[TRI-COUNTY FINANCIAL CORP. LETTERHEAD]
Dear Shareholder:
I am pleased to report to you the results of operations of Tri-County
Financial Corporation and its banking subsidiary, Community Bank of Tri-County,
for the year ended December 31, 2003. Our net income increased from 2002's level
by $478,077 to$2,445,989 or 24.29%. Basic earnings per share increased to $3.24
from $2.58 in 2002. Diluted earnings per share increased to $3.07 from $2.45.
Assets increased by over $69 million or 24.65%.
These positive improvements from the prior year's performance came despite
current levels of a very challenging low interest rate environment. As you are
aware, the historically low interest rates have produced a difficult environment
to realize any net interest rate spread appreciation. The Bank had enjoyed
record spreads through the end of 2001. Continued historically low interest
rates have led to declines in net interest income and net interest margin. These
decreases were partially offset by much lower noninterest expense in the current
year. The current recovery appears to be signaling a markedly different recovery
with low job creation and incredibly high productivity rates.
In order to increase future net interest income, the Bank has continued to
increase earning assets by leveraging its net worth. Asset growth totaled $69.6
million in 2003. Asset growth was concentrated in loans and investments which
should increase future interest income. Loan and investment quality continue to
be monitored by the Board in its efforts to maintain high credit quality assets
that can weather this most unusual post recessionary environment.
Core deposit growth during 2003 exceeded 12% or $24.5 million. In order to
continue to increase its deposit base, the Bank introduced internet banking in
the fourth quarter of 2003. Early results have been very promising as over 1,000
customers have signed up for this service in the first ninety days. We now offer
a full array of internet banking services such as bill pay, account transfer,
automatic deductions, ACH and other services. Progress also has been made in
bringing a Prince Frederick branch to our network. We hope that Prince Frederick
will be operational by the third quarter of 2004. I believe that the best course
of action for Community Bank to increase its market share will be to continue to
grow its branch network while adding non-branch delivery systems whenever
possible.
We are excited about the many business opportunities available in southern
Maryland, and we look forward to continuing to serve this community. As we move
forward, our shareholders continue to gain from an increasing franchise value
and earnings, which allowed a cash dividend increase of $.15 per share to $.70
per share, a 27% increase over the previous level.
The Board of Directors and management appreciate the support of our
shareholders and are committed to enhancing share value while serving the needs
of our many communities.
Yours truly,
/s/ Michael L. Middleton
Michael L. Middleton
President and Chairman
SELECTED FINANCIAL DATA
- -----------------------
The following table presents selected financial data for the Company and
its subsidiaries for the periods indicated.
Year Ended December 31,
------------------------------------------------------------
(Dollars in thousands except per share data)
2003 2002 2001 2000 1999
--------- ------ -------- -------- ------
OPERATIONS DATA:
Net Interest Income $ 10,469 $ 10,745 $ 9,757 $ 8,862 $ 8,412
Provision for Loan Losses 317 160 360 360 240
Noninterest Income 1,755 1,847 1,402 1,373 1,271
Noninterest Expense 8,428 9,398 6,995 6,332 6,276
Net Income 2,446 1,968 2,486 2,336 2,153
SHARE DATA:
Basic Net Income Per Common Share $ 3.24 $ 2.58 $ 3.24 $ 2.98 $ 2.75
Diluted Net Income Per Common Share 3.07 2.45 3.11 2.85 2.59
Cash Dividends Paid Per Common Share 0.55 0.50 0.40 0.30 0.20
Weighted Average Common
Shares Outstanding:
Basic 754,044 761,417 766,927 784,605 782,950
Diluted 796,021 804,122 798,787 821,139 832,283
FINANCIAL CONDITION DATA:
Total Assets $351,730 $282,128 $261,957 $248,339 $222,897
Loans Receivable, Net 217,740 197,449 193,450 172,090 146,710
Total Deposits 227,555 203,025 183,117 167,806 155,742
Long and Short Term Debt 94,242 48,922 50,463 54,951 44,798
Total Stockholders' Equity 27,912 26,873 25,586 23,430 21,115
PERFORMANCE RATIOS:
Return on Average Assets 0.78% 0.72% 0.97% 1.00% 1.00%
Return on Average Equity 8.99% 7.50% 10.09% 10.65% 10.23%
Net Interest Margin 3.55% 4.20% 4.00% 3.98% 4.11%
Efficiency Ratio 68.95% 74.73% 62.68% 61.86% 64.81%
Dividend Payout Ratio 17.27% 20.04% 12.44% 10.13% 7.29%
CAPITAL RATIOS:
Average Equity to Average
Assets 8.04% 9.53% 9.64% 9.37% 9.79%
Leverage Ratio 8.04% 9.53% 9.64% 9.61% 9.86%
Total Risk-Based Capital Ratio 12.20% 13.77% 14.08% 13.53% 17.23%
ASSET QUALITY RATIOS:
Allowance for Loan Losses to
Total Loans 1.16% 1.15% 1.16% 1.10% 1.11%
Nonperforming Loans to Total Loans 0.17% 0.30% 0.12% 0.06% 0.26%
Allowance for Loan Losses to
Nonperforming Loans 678.30% 387.60% 996.07% 1770.55% 424.94%
Net Charge-offs to Average Loans 0.03% 0.06% 0.01% 0.05% 0.09%
1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
- --------------------------------------------------------------------------------
OVERVIEW
Since its conversion to a commercial bank charter in 1997, the Community Bank of
Tri County (the "Bank") has sought to increase total assets as well as certain
targeted loan types. The Bank feels that its ability to offer fast, flexible and
local decision-making in the commercial, commercial real estate, and consumer
loan areas will continue to attract significant new loans and enhance asset
growth. The Bank's local focus and targeted marketing is also directed towards
increasing its balances of consumer and business transaction deposit accounts.
The Bank believes that increases in these account types will lessen the Bank's
dependence on time deposits such as certificates of deposit to fund loan growth.
Although management believes that the strategy outlined above will increase
financial performance over time, we recognize that products such as commercial
lending and transaction accounts will also increase the Bank's noninterest
expense. We also recognize that certain lending and deposit products also
increase the possibility of losses from credit and other risks.
FORWARD-LOOKING STATEMENTS
When used in this discussion and elsewhere in this Annual Report on Form 10-K,
the words or phrases "will likely result," "are expected to," "will continue,"
"is anticipated," "estimate," "project" or similar expressions are intended to
identify "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. The Tri County Financial Corporation
(the "Company") cautions readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made, and to advise
readers that various factors, including regional and national economic
conditions, unfavorable judicial decisions, substantial changes in levels of
market interest rates, credit and other risks of lending and investment
activities and competitive and regulatory factors could affect the Company's
financial performance and could cause the Company's actual results for future
periods to differ materially from those anticipated or projected.
The Company does not undertake and specifically disclaims any obligation to
update any forward-looking statements to reflect occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America
("GAAP") and the general practices of the United States banking industry.
Application of these principles requires management to make estimates,
assumptions, and judgments that affect the amounts reported in the financial
statements and accompanying notes. These estimates, assumptions and judgments
are based on information available as of the date of the financial statements;
accordingly, as this information changes, the financial statements could reflect
different estimates, assumptions, and judgments. Certain policies inherently
have a greater reliance on the use of estimates, assumptions and judgments and
as such have a greater possibility of producing results that could be materially
different than originally reported. Estimates, assumptions, and judgments are
necessary when assets and liabilities are required to be recorded at fair value,
when a decline in the value of an asset not carried on the financial statements
at fair value warrants an impairment write-down or valuation reserve to be
established, or when an asset or liability needs to be recorded contingent upon
a future event. Carrying assets and liabilities at fair value inherently results
in more financial statement volatility. The fair values and the information used
to record valuation adjustments for certain assets and liabilities are based
either on quoted market prices or are provided by other third-party sources,
when available. When these sources are not available, management makes estimates
based upon what it considers to be the best available information.
The allowance for loan losses is an estimate of the losses that may be sustained
in our loan portfolio. The allowance is based on two principles of accounting:
(a) Statement on Financial Accounting Standards ("SFAS") No. 5, "Accounting for
Contingencies", which requires that losses be accrued when they are probable of
occurring and are estimable and (b) SFAS No. 114, "Accounting by Creditors for
Impairment of
2
a Loan", which requires that losses be accrued when it is probable that the
Company will not collect all principal and interest payments according to the
contractual terms of the loan. The loss, if any, is determined by the difference
between the loan balance and the value of collateral, the present value of
expected future cash flows, or values observable in the secondary markets.
Our loan loss allowance balance is an estimate based upon management's
evaluation of its loan portfolio. Generally the allowance is comprised of a
specific and a nonspecific component. The specific component consists of
management's evaluation of certain loans and their underlying collateral. Loans
are examined to determine the specific allowance based upon their payment
history, economic conditions specific to the loan or borrower, or other factors
that would impact the borrower's ability to repay the loan on its contractual
basis. Management assesses the ability of the borrower to repay the loan based
upon any information available. Depending on the assessment of the borrower's
ability to pay the loan as well as the type, condition, and amount of
collateral, management will establish an allowance amount specific to the loan.
In establishing a nonspecific loan loss amount, management analyzes the current
composition of the loan portfolio including changes in the amount and type of
loans. Management also examines the Bank's history of write-offs and recoveries
within each loan category. The state of the local and national economy is also
considered. Based upon these factors the Bank's loan portfolio is categorized
and a possible loss factor is applied to each category. These loss factors may
be higher or lower than the Bank's actual recent average losses in any
particular loan category, particularly in loan categories where the Bank is
rapidly increasing the size of its portfolio. Based upon these factors the Bank
will adjust the loan loss allowance by increasing or decreasing the provision
for loan losses.
Management has significant discretion in making the judgments inherent in the
determination of the provision and allowance for loan losses, including in
connection with the valuation of collateral, a borrower's prospects of
repayment, and in establishing allowance factors on the nonspecific component of
the allowance. Changes in allowance factors will have a direct impact on the
amount of the provision, and a corresponding effect on net income. Errors in
management's perception and assessment of the global factors and their impact on
the portfolio could result in the allowance not being adequate to cover losses
in the portfolio, and may result in additional provisions or charge-offs. For
additional information regarding the allowance for credit losses, refer to Notes
1 and 3 to the Consolidated Financial Statements and the discussion under the
caption "Provision for Loan Losses" below.
In addition to the loan loss allowance, the Company also maintains a valuation
allowance on its foreclosed real estate assets. As with the allowance for loan
losses the valuation allowance on foreclosed real estate is based on SFAS No. 5,
"Accounting for Contingencies," as well as SFAS No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets." These statements require that the
Company establish a valuation allowance when it has determined that the carrying
amount of a foreclosed asset exceeds its fair value. Fair value of a foreclosed
asset is measured by the cash flows expected to be realized from its subsequent
disposition. These cash flows should be reduced for the costs of selling or
otherwise disposing of the asset.
In estimating the cash flow from the sale of foreclosed real estate, management
must make significant assumptions regarding the timing and amount of cash flows.
In cases where the real estate acquired is undeveloped land, management must
gather the best available evidence regarding the market value of the property,
including appraisals, cost estimates of development, and broker opinions. Due to
the highly subjective nature of this evidence, as well as the limited market,
long time periods involved, and substantial risks, cash flow estimates are
highly subjective and subject to change. Errors regarding any aspect of the
costs or proceeds of developing, selling, or otherwise disposing of foreclosed
real estate could result in the allowance being inadequate to reduce carrying
costs to fair value and may require an additional provision for valuation
allowances.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002
AND 2001
GENERAL. For the year ended December 31, 2003, the Company reported consolidated
net income of $2,445,898 ($3.24 basic and $3.07 diluted earnings per share)
compared to consolidated net income of
3
$1,967,821 ($2.58 basic and $2.45 diluted earnings per share) for the year ended
December 31, 2002, and consolidated net income of $2,485,535 ($3.24 basic and
$3.11 diluted earnings per share) for the year ended December 31, 2001. The
increase in net income for 2003 compared to 2002 was primarily attributable to a
decline in noninterest expenses in 2003. Noninterest expenses were higher in
2002 than in 2003 primarily because of the establishment of a valuation
allowance on foreclosed real estate and expenses incurred as a result of a core
data systems conversion in 2002. These reductions in certain noninterest expense
categories were partially offset by a decline in net interest income, an
increase in the provision for loan losses, a decline in noninterest income, and
increases in certain categories of noninterest expenses. For the year ended
December 31, 2003, net interest income declined by $276,834 to $10,468,526 a
decrease of 2.58%. The Company increased its provision for loan losses to
$316,963 from $160,000 in the prior year an increase of 98.1% or $156,963.
Noninterest income declined to $1,754,538 for the year ended December 31, 2003 a
decrease of $92,523 or 5.01% from the prior year. These negative factors were
offset by a decrease in noninterest expense from $9,397,600 for the year ended
December 31, 2002 to $8,427,771 for the year ended December 31, 2003, a decline
of 10.32%. Income before income taxes increased to $3,478,330 for the year ended
December 31, 2003, an increase of $443,509 or 14.61%. Income tax expense
decreased to $1,032,432 for the year ended December 31, 2003, a decline from the
prior year of $34,568 or 3.24%.
For the year ended December 31, 2002, net interest income was $10,745,360
compared to $9,714,216 for the year ended December 31, 2001, an increase of
$1,031,144 or 10.61%. The Company also increased total noninterest income to
$1,847,061 in 2002 from $1,401,520 in 2001, an increase of $445,541 or 31.79%.
Noninterest expenses increased to $9,397,600 for the year ended December 31,
2002, compared to $6,951,851 an increase of $2,445,749 or 35.18%. Income before
income taxes decreased to $3,034,821 for the year ended December 31, 2002,
compared to $3,803,885 for the year ended December 31, 2001, a decrease of
$769,064 or 20.22%. Income tax expense for 2002 decreased to $1,067,000 from
$1,318,350 for the year ended December 31, 2001, a decline of 19.07% or
$251,350.
NET INTEREST INCOME. The primary component of the Company's net income is its
net interest income which is the difference between income earned on assets and
interest paid on the deposits and borrowings used to fund them. Net interest
income is determined by the spread between the yields earned on the Company's
interest-earning assets and the rates paid on interest-bearing liabilities as
well as the relative amounts of such assets and liabilities. Net interest
income, divided by average interest-earning assets, represents the Company's net
interest margin.
Consolidated net interest income for the year ended December 31, 2003 was
$10,468,526 compared to $10,745,360 for the year ended December 31, 2002 and
$9,714,216 for the year ended December 31, 2001. The $276,834 decrease in the
most recent year was due to decreases in both interest income and interest
expense with the decrease in interest income of $549,063 offset by the decrease
in interest expense of $272,229. For the year ended December 31, 2002, the
$1,031,144 increase was due to a decrease of $1,758,039 in interest income
offset by a decrease of $2,789,183 in interest expense for the same period.
Changes in the components of net interest income due to changes in average
balances of assets and liabilities and to changes caused by changes in interest
rates are presented in the rate volume analysis below.
During 2003, the Company's interest rate spread decreased because the Bank was
unable to lower the interest rates paid on deposits and borrowings as quickly
and as much as the interest rates earned on loans and investments fell. Rates on
deposits, particularly interest bearing transaction and money market accounts
had already been very low in 2002, as interest rates fell in 2003, the rates
paid on these deposits decreased slightly while the rates on investments and
loans decreased by a greater amount. In addition the percentage of funding
contributed by relatively higher cost borrowings compared to deposits increased.
The following table presents information on the average balances of the
Company's interest-earning assets and interest-bearing liabilities and interest
earned or paid thereon for the past three fiscal years.
4
(Dollars in Thousands)
---------------------------------------------------------------------------------------
For the Year Ended December 31,
---------------------------------------------------------------------------------------
2003 2002 2001
----------------------------- -------------------------- --------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance(1) Interest Cost Balance(1) Interest Cost Balance(1) Interest Cost
------- -------- ---- ------- -------- ---- ------- -------- ----
Interest-earning assets:
Loan portfolio $201,440 $13,412 6.66% $195,280 $14,221 7.28% $184,370 $15,223 8.26%
Investment securities, federal funds
sold and interest bearing deposits 93,261 2,753 2.95% 60,637 2,493 4.11% 58,276 3,249 5.57%
------- ----- ----- ------ ----- ----- ------ ----- ----
Total interest-earning assets 294,702 16,165 5.49% 255,917 16,714 6.53% 242,646 18,472 7.61%
------- -------- ----- ------- -------- ----- ------- -------- ----
Interest-bearing liabilities:
Interest bearing deposits $212,643 $ 2,869 1.35% $189,518 $ 3,453 1.82% $175,919 $ 5,935 3.37%
Borrowings 68,679 2,828 4.12% 48,487 2,515 5.19% 52,387 2,822 5.39%
------- ----- ----- ------ ----- ----- ------ ----- -----
Total interest-bearing liabilities 281,322 5,696 2.02% 238,005 5,969 2.51% 228,306 8,758 3.84%
======= ===== ===== ======= ===== ===== ======= ===== =====
Net interest income $10,469 $10,745 $ 9,714
======= ======= =======
Interest rate spread 3.46% 4.02% 3.78%
===== ===== =====
Net yield on interest-earning assets 3.55% 4.20% 4.00%
===== ===== =====
Ratio of average interest-earning
assets to average interest bearing
liabilities 104.76% 107.53% 106.28%
======= ======= =======
- ---------
(1) Average balance includes non-accrual loans.
5
The table below sets forth certain information regarding changes in interest
income and interest expense of the Bank for the periods indicated. For each
category of interest-earning asset and interest-bearing liability, information
is provided on changes attributable to: (1) changes in volume (changes in volume
multiplied by old rate); and (2) changes in rate (changes in rate multiplied by
old volume). Changes in rate-volume (changes in rate multiplied by the change in
volume) have been allocated to changes due to volume.
2003 2002
Due to Due to
------------------------------------ ------------------------------------
Volume Rate Total Volume Rate Total
---------- ---------- --------- --------- --------- --------
Interest income:
Loan portfolio $ 410 $ (1,220) $(809) $ 795 $(1,797) $(1,002)
Interest-earning cash and
investment portfolio 963 (703) 260 97 (853) (756)
-------- --------- ------ ----- ------- --------
Total interest-earning assets $ 1,373 $ (1,922) $(549) $ 892 $(2,650) $ (1,758)
======== ========= ====== ====== ======== =========
Interest expense:
Savings deposits and escrows $ 312 $(897) $(585) $ 241 $(2,723) $ (2,482)
FHLB advances and other
borrowings 831 (519) 313 (201) (106) (307)
-------- --------- ----- ----- ------- --------
$ 1,143 $ (1,416) $(272) $ 40 $(2,829) $ (2,789)
======== ========= ====== ====== ======== =========
PROVISION FOR LOAN LOSSES. Provision for loan losses for the year ended December
31, 2003 was $316,963 compared to $160,000 and $360,000 for December 31, 2002
and 2001, respectively. The higher provision for loan losses in 2003 is due to
the increase in the size of the loan portfolio as well as the higher
concentration of loans in types with higher credit risk. These factors were
partially offset by the Bank's continued low levels of delinquency and
charge-offs. The loan loss allowance and the provision for loan losses is
determined based upon an analysis of individual loans and the application of
certain loss factors to different loan categories. Individual loans are analyzed
for impairment as the facts and circumstances warrant. In addition, a
nonspecific component of the loan loss allowance is added based on a review of
the portfolio's size and composition. At December 31, 2003 the allowance for
loan loss equaled 678% of non-accrual and past due loans compared to 388% and
997% at December 31, 2002 and 2001, respectively. During the year ended December
31, 2003, the Company recorded net charge-offs of $58 thousand (.03% of average
loans) compared to $128 thousand (0.06% of average loans) compared to $8
thousand (0.00% of average loans) in net charge-offs during the years ended
December 31, 2002 and 2001.
NONINTEREST INCOME. Noninterest income decreased to $1,754,538 for the year
ended December 31, 2003 compared to $1,847,061, for the prior year, a decrease
of 5.01%. Noninterest income for the year ended December 31, 2002 represented an
increase of 31.79% from the December 31, 2001 total of $1,401,520. Changes in
noninterest income over the past three years have been the result of wide
fluctuations in certain noninterest income categories, (gain on sale of loans,
other income, and loan fees) and an increase in income from Bank Owned Life
Insurance ("BOLI") in the current year. Gain on sale of loans held-for-sale has
been highly variable reflecting the overall interest rate environment. Gain on
the sale of loans increased from $187,304 in 2001 to 499,304 and 505,435 in 2002
and 2003 respectively.
Loan appraisal, credit and miscellaneous charges are highly variable; from 2002
to 2003, these charges increased to $261,387 an increase of 46.02%. The increase
was due to the increase in loan activity, particularly in commercial and
commercial real estate lending. In 2002, these charges decreased to $179,006
from the 2001 level of $226,641 a decrease of 21.02% despite a high volume of
loan transactions. This decrease was caused by the market trends towards low and
no cost residential mortgage loan products.
6
As rates decrease, the Bank's volume of fixed rate mortgage lending increases,
which in turn has provided a higher volume of loan sales and gains. In 2002 and
2003, interest rates decreased from 2001 levels and income from gain on sale of
mortgage loans increased to $505,435 and $499,304 respectively from the 2001
level of $187,304. In percentages, income from the sales of mortgages increased
by 166.57% from 2001 to 2002 and increased by a further 1.23% in 2003. The Bank
may elect to add more fixed rate residential mortgage loans to its portfolio in
the future, which would negatively impact its income from the gain on sale of
mortgage loans. Income from BOLI increased to $230,607 in 2003 from none in the
two prior years. The income from BOLI income in 2003 was the result of the
purchase of BOLI in 2003. Service charges and fees are primarily generated by
the Bank's ability to attract and retain transaction-based deposit accounts and
by loan servicing fees net of amortization of and valuation allowances on
mortgage servicing rights. In 2003, service charges and fees declined to
$695,128 from 2002's level of $1,041,662, a decline of $346,534 or 33.27%. This
decline was primarily caused by an increase in the amortization of mortgage
servicing rights and valuation allowances. Service charges and fees increased to
$1,041,662 for the year ended December 31, 2002 as compared to $953,496 in the
prior year. The increase for the year ended December 31, 2002 from the prior
year was $88,166, or 9.3%. The Bank hopes to increase its service charge and fee
revenues in the future by increasing the level of transaction-based accounts.
Finally, other noninterest income decreased from 2002 to 2003 and increased from
2001 to 2002. For the year ended December 31, 2003, other noninterest income was
$61,981, a decrease of $65,108 from the prior year total of $127,089.
NONINTEREST EXPENSES. Noninterest expenses for the year ended December 31, 2003
totaled $8,427,771, a decrease of $969,829 or 10.32% from the prior year. Salary
and employee benefits increased by 11.21% to $4,702,181 for the year ended
December 31, 2003 compared to $4,228,050 for the prior year. The increase
reflects growth in the Bank's workforce to fully staff branches as well as an
increasing need for highly skilled employees due to the higher complexity level
of the Bank's business. Expenses also included certain supplemental retirement
benefits which were funded by the BOLI income. Occupancy expense decreased to
$750,567 compared to $831,148 and $689,575 in the two prior years. Occupancy
expenses decreased in 2003 by $80,513 or 9.70% from 2002 as the result of the
elimination of certain nonrecurring expenses in 2002. These expenses included
repair work as well as the costs of temporary facilities needed prior to the
opening of the Bank's Charlotte Hall branch. Occupancy expenses in 2002
increased from 2001 due to the expenses noted above as well as the costs of
adding the Charlotte Hall branch. Advertising decreased from 2002 levels to
$308,951 for the year ended December 31, 2003 compared to $338,216 and $301,975
in the two prior years, respectively. Most advertising costs were incurred
attempting to build our transaction deposit base. Data processing expense
decreased to $403,967 from the prior year total of $568,095 a decrease of
28.89%. The Bank incurred significant costs related to its conversion in this
category in 2002. These costs included training, consulting, and transition fees
related to the conversion process. These factors led to the increase in data
processing expense from 2001 to 2002 totaling $276,696 or 94.95%. The increase
in data processing expense from 2001 to 2002 is also reflective of the Company's
additional transaction based deposit accounts and an increase in overall deposit
volume. Loss on disposal of obsolete equipment totaled $65,104 in 2002. These
expenses related to the write-off of certain equipment that could not support
the new core data system. Depreciation of furniture, fixtures, and equipment
increased from $263,535 in 2001, to $339,184 in 2002, to $507,236 in 2003. The
increase from 2001 to 2002 reflects the Bank's opening of certain locations, an
adjustment of shorter useful lives assigned to new assets, and additional assets
purchased to facilitate the data processing conversion. In 2003, depreciation of
furniture, fixtures, and equipment again increased due to the large amount of
equipment purchased in the prior year. Telephone communications expenses
decreased to $166,553 in 2003, a decrease of $179,006 or 51.80%. Telephone
communications expenses decreased in 2003 because 2002 expenses included certain
data processing conversion costs. Expenses similarly increased from 2001 to 2002
because of the 2002 conversion costs. In 2002, the Bank recorded a valuation
allowance of $972,889 on its foreclosed real estate. No valuation allowances on
foreclosed assets were recorded in 2001 or 2003. ATM expenses decreased in 2003
by $38,012 or 12.18% from $312,200 in 2002 to $274,188 in 2003. ATM expenses
were $254,175 in 2001. The increase in 2002 was related to conversion costs.
Office supplies expense also decreased in 2003 from 2002 (by $159,408 or 54.85%)
because of conversion related expenses in 2002. From 2001 to 2002 office
supplies expense increased from $253,545 to $290,636 or by 14.63%, with the
increase in 2002 being related to the conversion expenses mentioned above.
Office equipment expenses decreased to $129,849 in 2003 from $247,171 in 2002, a
decrease of $117,322 or
7
47.47%. This decrease relates to higher expenses incurred during the conversion
process in 2002, as well as the reduction of ongoing equipment costs related to
the old data processing system.
INCOME TAX EXPENSE. During the year ended December 31, 2003, the Company
recorded income tax expense of $1,032,432 compared to expenses of $1,067,000 and
$1,318,350 in the two prior years. The Company's effective tax rates for the
years ended December 31, 2003, 2002, and 2001 were 29.7%, 35% and 34.7%,
respectively. The 2003 effective tax rate declined due to an increase in
non-taxable income and a slight decrease in state taxes. The slight increase in
the tax rate during 2002 from 2001 was primarily attributable to an increase in
certain non-deductible costs.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2003 AND 2002
In 2003, the Bank began to increase asset growth to increase its net interest
income and net income. The asset growth was concentrated in investment
securities and loans. This asset growth was funded primarily by an increase in
borrowed funds. Cash balances were also invested in the increased balances of
loans and investments. The Bank intends to continue to increase its asset size
in 2004. In 2003, the Company's total assets increased $69,556,297, or 24.65%,
to $351,729,992 as of December 31, 2003 from $282,173,695 at December 31, 2002.
The increase in assets was primarily in investment securities held to maturity,
loans, and investment in BOLI and loans. These increases in assets were for the
purpose of increasing net interest income and noninterest income to offset the
lower interest rate spread realized in 2003. Cash and due from banks decreased
by $7,674,126 or 76.79%. Interest-bearing deposits with banks also decreased by
41.29% or $6,267,519. These declines were used to fund increases in investment
securities held to maturity. Fed funds sold increased by $574,660 or 158.09% to
$938,166. Federal funds balances vary greatly from month to month and this
fluctuation is not unusual. Investment securities available for sale decreased
by $3,536,039 or 8.45%, the decline was due to payments on existing securities
which more than offset current year purchases. Investments held to maturity
increased by $58,763,368 or 2067.82%. This increase was due to the Company's
effort to build investment balances to increase net interest income. Stock in
the Federal Home Loan Bank increased due to stock purchases made necessary by
increased Federal Home Loan Bank borrowing levels. Loans held for sale declined
by $787,787 or 62.39%, as current loan production is increasingly held in the
Bank's portfolio. Loans receivable increased by $20,290,871or 10.28%, as the
Bank continued to build assets in 2003 to increase net interest income.
Premises and equipment decreased slightly to $5,580,189 from $5,736,395 a
decrease of 2.72% or $156,206. This decrease was due to a slower level of
purchases of premises and equipment combined with shorter asset lives.
Foreclosed real estate declined by $9,250 due to collections on foreclosed
properties. BOLI increased due to the purchase of the policies in 2003, and
other assets increased slightly to $3,146,247 due to an increase in certain
prepaid tax accounts.
Deposits increased to $227,554,568 at December 31, 2003 compared to $203,025,112
for the prior year. The total increase of 12.08% was concentrated in interest
bearing account types which offset a decrease in noninterest bearing deposits.
Short and long term debt increased as the Company sought to add assets to
increase net interest income offsetting a decline in interest spread. The
increases in short and long term debt were $30,438,987 and $14,881,176
respectively or 4046.13% and 30.89% which increased balances in these accounts
to $31,191,285 and $63,051,176 respectively. The proceeds of this debt were used
to purchase investments and fund loans as noted above.
The Company experienced a $1,039,145, or 3.87%, increase in stockholders' equity
for the year ended December 31, 2003. The increase in stockholders' equity was
attributable to the retention of earnings from the period $2,445,898, less cash
dividends $422,361. Equity was also increased by the exercise of stock options
totaling $200,551 and activity in the ESOP shares resulting in a gain of
$63,435. These increases were partially offset by unrealized losses on available
for sale investment in the amount of $496,821 and the repurchase of common stock
in the amount of $769,720.
8
ASSET/LIABILITY MANAGEMENT
Net interest income, the primary component of the Company's net income, arises
from the difference between the yield on interest-earning assets and the cost of
interest-bearing liabilities and the relative amounts of such assets and
liabilities. The Company manages its assets and liabilities by coordinating the
levels of and gap between interest-rate sensitive assets and liabilities to
control changes in net interest income and in the economic value of its equity
despite changes in market interest rates.
Among other tools used to monitor interest rate risk is a "gap" report which
measures the dollar difference between the amount of interest-earning assets and
interest-bearing liabilities subject to repricing within a given time period.
Generally, during a period of rising interest rates, a negative gap position
would adversely affect net interest income, while a positive gap would result in
an increase in net interest income. While, conversely, during a period of
falling interest rates, a negative gap would result in an increase in net
interest income and a positive gap would adversely affect net interest income.
The following sets forth the Bank's gap position at December 31, 2003:
Over 3 to 12 Over 1
0-3 Months Months through 5 Years Over 5 Years
---------- ------------ --------------- -------------
(amounts in thousands)
Assets:
Cash and due from banks $ 2,319 $ -- $ -- $ --
Interest-bearing deposits 8,912 -- -- --
Fed Funds sold 938 -- -- --
Securities 7,332 10,921 34,611 47,031
Loans held for sale 475 -- -- --
Loans 55,447 12,770 46,956 105,789
--------- ----------- ----------- ----------
Total Assets $ 75,423 $ 23,692 $ 81,567 $ 152,820
========= =========== =========== ==========
Liabilities:
Noninterest bearing deposits $ 29,270 $ -- $ -- $ --
Interest bearing demand deposits 29,674 -- -- --
Money market deposits 44,473 -- -- --
Savings 34,671 -- -- --
Certificates of deposit 12,730 44,867 31,869 --
Short-term debt 31,191 -- -- --
Long-term debt 88 -- 32,074 30,889
---------- ----------- ----------- ----------
Total Liabilities $ 182,098 $ 44,867 $ 63,943 $ 30,889
========== =========== =========== ==========
Gap $(106,675) $ (21,175) $ 17,624 $ 121,931
Cumulative Gap $(106,675) $ (127,850) $ (110,225) $ 11,705
Cumulative Gap as a percentage of
total assets -30.33% -36.35% -31.34% 3.33%
The foregoing analysis assumes that the Bank's assets and liabilities move with
rates at their earliest repricing opportunities based on final maturity.
Mortgage-backed securities are assumed to mature during the period in which they
are estimated to prepay and it is assumed that loans and other securities are
not called nor do they prepay prior to maturity. Certificates of deposit and IRA
accounts are presumed to
9
reprice at maturity. NOW and savings accounts are assumed to reprice within
three months although it is the Company's experience that such accounts may be
less sensitive to changes in market rates.
As noted above the Bank, has a substantial excess of liabilities over assets
repricing or maturing within one year. This would indicate that the Bank's net
interest income would decline if interest rates were to increase. A decrease in
net interest income as a result of a general increase in rates is likely, but
the Bank has the ability to moderate the effect of a general increase in
interest rates by controlling increases in rates on transaction accounts, using
available cash to reduce the amounts in particularly rate sensitive liability
accounts, and increasing total assets through increased leverage. In addition,
the analysis above substantially understates the amount of loan prepayments the
Bank has historically experienced even in periods of rising interest rates.
LIQUIDITY AND CAPITAL RESOURCES
The Company currently has no business other than that of the Bank and does not
currently have any material funding commitments. The Company's principal sources
of liquidity are cash on hand and dividends received from the Bank. The Bank is
subject to various regulatory restrictions on the payment of dividends.
The Bank's principal sources of funds for investments and operations are net
income, deposits from its primary market area, principal and interest payments
on loans, interest received on investment securities and proceeds from maturing
investment securities. Its principal funding commitments are for the origination
or purchase of loans and the payment of maturing deposits. Deposits are
considered the primary source of funds supporting the Bank's lending and
investment activities. The Bank also uses borrowings from the FHLB of Atlanta to
supplement deposits. The amount of FHLB advances available to the Bank is
limited to the lower of 35% of Bank assets or the amount supportable by eligible
collateral including FHLB stock, current residential first mortgage loans, and
certain securities.
The Bank's most liquid assets are cash, cash equivalents, and federal funds
sold. The levels of such assets are dependent on the Bank's operating financing
and investment activities at any given time. The variations in levels of cash
and cash equivalents are influenced by deposit flows and anticipated future
deposit flows.
Cash, cash equivalents, and interest-bearing deposits as of December 31, 2003
totaled $12,169,798, a decrease of $13,366,985 (52.34%) from the December 31,
2001 total of $25,536,783. This decrease was due to the Bank's investment in
securities as noted above.
The Company's principal sources of cash flows are its financing activities
including deposits and borrowings. During the year 2003, all financing
activities provided $68,939,687 in cash compared to $17,747,865 during 2002 and
$9,823,609 during 2001. The increase in cash flows from financing activities
during the most recent period was principally due to an increase in borrowing
activity in 2003. The proceeds of long term borrowing increased to $15,000,000
in 2003 compared to $920,000 in 2002, and $12,250,000 in 2001. Short-term
borrowing provided a net increase in cash of $30,438,987 in 2003 compared to a
use of cash in 2002 of $1,061,019. During 2003, net deposit growth was
$24,529,456 compared to $19,908,578 in 2002. The Company also receives cash from
its operating activities which provided $2,347,573 in cash during 2003, compared
to cash flows of $4,159,722 and $5,012,228 during 2002 and 2001, respectively.
The decrease in operating cash flows during 2003 was primarily due to a decrease
in accrued expenses and other liabilities.
The Company's principal use of cash has been in investing activities including
its investments in loans for portfolio, investment securities and other assets.
During the year ended December 31, 2002, the Company invested a total of
$78,961,386 in its investing activities compared to $18,364,135 in 2002 and
$9,750,117 in 2001. The principal reason for the increase in cash used in
investing activities was an increase in the purchase of investments over the
proceeds of sales, redemptions, and principal reductions.
Federal banking regulations require the Company and the Bank to maintain
specified levels of capital. At December 31, 2003 the Company was in compliance
with these requirements with a leverage ratio of
10
8.04%, a Tier 1 risk-based capital ratio of 11.17% and total risk-based capital
ratio of 12.20%. At December 31, 2003, the Bank met the criteria for designation
as a well-capitalized depository institution under FRB regulations.
OFF BALANCE SHEET ARRANGEMENTS
In the normal course of its business the Bank has committed to make credit
available to its borrowers under various loan and other agreements provided that
certain terms and conditions are met. For a discussion of these agreements
including collateral and other arrangements see Note 10 to the Company's Audited
Financial Statements dated December 31, 2003.
CONTRACTUAL OBLIGATIONS
In the normal course of its business, the Bank commits to make future payments
to others to satisfy contractual obligations. These commitments include the
following: commitments to repay short and long term borrowings, and commitments
incurred under operating lease agreements. These commitments are summarized
below:
PAYMENTS DUE BY PERIOD LESS MORE THAN
(IN 000'S) THAN 1-3 3-5 5
TOTAL 1 YEAR YEARS YEARS YEARS
------ ------ ----- ----- -----
Long Term Debt Obligations $ 63,051 $ 88 $ 32,074 -- $ 30,889
Short Term Debt Obligations 31,191 31,191 -- -- --
Deposits 227,555 195,684 18,539 13,332 --
Purchase obligations 1,401 501 720 180 --
Operating Lease Obligations 1,208 181 543 293 192
------ -------- -------- -------- --------
$324,406 $227,645 $ 51,876 $ 13,805 $ 31,081
======== ======== ======== ======== ========
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements and notes thereto presented herein have
been prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in terms of
historical dollars without considering the changes in the relative purchasing
power of money over time due to inflation. Unlike most industrial companies,
nearly all of the Company's assets and liabilities are monetary in mature. As a
result, interest rates have a greater impact on the Company's performance than
do the effects of general levels of inflation. Interest rates do not necessarily
move in the same direction or to the same extent as the prices of goods and
services.
MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS
- ----------------------------------------------------------------------------
MARKET INFORMATION. The following table sets forth high and low bid quotations
reported on the OTC Bulletin for the Company's common stock for each quarter
during 2002 (beginning January 30, 2002) and 2003. These quotes reflect
inter-dealer prices without retail mark-up, mark-down or commission and may not
necessarily reflect actual transactions.
2002 High Low
---- ---
Fourth Quarter $39.38 $36.50
Third Quarter 37.00 30.25
Second Quarter 30.25 28.00
First Quarter 28.50 23.40
11
2003 High Low
---- ---
Fourth Quarter $43.00 $39.00
Third Quarter 40.00 39.00
Second Quarter 39.00 37.00
First Quarter 39.00 37.00
HOLDERS. The number of stockholders of record of the Company at December 31,
2003 was 529.
DIVIDENDS. The Company has paid annual cash dividends since 1994. During fiscal
years 2003 and 2002, the Company paid cash dividends of $0.55 and $0.50,
respectively. On February 4, 2004, the Board of Directors declared a $0.70 per
share cash dividend to be distributed on April 12, 2004 to holders of record as
of March 22, 2004.
The Company's ability to pay dividends is governed by the policies and
regulations of the FRB, which prohibit the payment of dividends under certain
circumstances dependent on the Company's financial condition and capital
adequacy. The Company's ability to pay dividends is also dependent on the
receipt of dividends from the Bank.
Federal regulations impose certain limitations on the payment of dividends and
other capital distributions by the Bank. The Bank's ability to pay dividends is
governed by the Maryland Financial Institutions Code and the regulations of the
FRB. Under the Maryland Financial Institution Code, a Maryland bank (1) may only
pay dividends from undivided profits or, with prior regulatory approval, its
surplus in excess of 100% of required capital stock and (2) may not declare
dividends on its common stock until its surplus funds equals the amount of
required capital stock or, if the surplus fund does not equal the amount of
capital stock, in an amount in excess of 90% of net earnings.
Without the approval of the FRB, a state member bank may not declare or pay a
dividend if the total of all dividends declared during the year exceeds its net
income during the current calendar year and retained net income for the prior
two years. The Bank is further prohibited from making a capital distribution if
it would not be adequately capitalized thereafter. In addition, the Bank may not
make a capital distribution that would reduce its net worth below the amount
required to maintain the liquidation account established for the benefit of its
depositors at the time of its conversion to stock form.
12
TRI-COUNTY FINANCIAL CORPORATION
BOARD OF DIRECTORS
[PHOTO OF FULL
BOARD OF DIRECTORS APPEARS HERE]
[INDIVIDUAL PHOTOS OF DIRECTORS APPEAR BELOW]
Michael L. Middleton C. Marie Brown H. Beaman Smith
President and Executive Vice President Secretary/Treasurer
Chairman of the Board Chief Operating Officer President
Accoware Systems
Herbert N. Redmond, Jr. James R. Shepherd
Senior Vice President Business Development Officer
D.H. Steffens Company Calvert County Department of Economic Development
Louis P. Jenkins, Jr. A. Joseph Slater, Jr.
Partner President
Louis P. Jenkins, P.A. Southern Maryland Electric Cooperative
TRI-COUNTY FINANCIAL CORPORATION
BANK RISK ASSESSMENT TEAM
[PHOTO OF
BANK RISK ASSESSMENT TEAM APPEARS HERE]
[INDIVIDUAL PHOTOS OF TEAM APPEAR BELOW]
Michael L. Middleton C. Marie Brown Gregory C. Cockerham
President and Executive Vice President Executive Vice
Chairman of the Board Chief Operating Officer President
Chief Lending Officer
William J. Pasenelli David D. Vaira John H. Buckmaster
Executive Vice President Senior Vice President Vice President
Chief Financial Officer Controller Commercial Loan
Officer
Paige Watkins David Sjogren Megan Pierce
Vice President Compliance Officer Sales Manager
Credit Administrator
Nancy Hayden
Director of Information Technology
TRI-COUNTY FINANCIAL CORPORATION
SENIOR MANAGEMENT TEAM
[PHOTO OF
SENIOR MANAGEMENT TEAM APPEARS HERE]
[INDIVIDUAL PHOTOS OF TEAM APPEAR BELOW]
Michael L. Middleton C. Marie Brown
President and Executive Vice President
Chairman of the Board Chief Operating Officer
Gregory C. Cockerham William J. Pasenelli
Executive Vice Executive Vice President
President Chief Financial Officer
Chief Lending Officer
SHAREHOLDER RELATIONS
- ---------------------
Christy Lombardi
TRI-COUNTY FINANCIAL CORPORATION
REPORT ON AUDITS OF
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED
DECEMBER 31, 2003, 2002, AND 2001
TABLE OF CONTENTS
INDEPENDENT AUDITORS' REPORT
CONSOLIDATED FINANCIAL STATEMENTS Page
----
Balance Sheets 4
Statements of Income 5
Statements of Changes in Stockholders' Equity 6
Statements of Cash Flows 7 - 8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 9 - 34
[LETTERHEAD OF STEGMAN & COMPANY]
Independent Auditors' Report
Audit Committee of the
Board of Directors and Stockholders
Tri-County Financial Corporation
We have audited the accompanying consolidated balance sheets of Tri-County
Financial Corporation as of December 31, 2003 and 2002, and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2003. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Tri-County Financial Corporation as of December 31, 2003 and 2002, and the
results of its consolidated operations and cash flows for each of the three
years in the period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States of America.
/s/ Stegman & Company
Baltimore, Maryland
February 13, 2004
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2003 AND 2002
ASSETS
2003 2002
Cash and due from banks $ 2,319,300 $ 9,993,426
Interest-bearing deposits with banks 8,912,332 15,179,851
Federal funds sold 938,166 363,506
Investment securities available for sale - at fair value 38,290,074 41,826,113
Investment securities held to maturity - at amortized cost 61,605,175 2,841,807
Stock in Federal Home Loan Bank and Federal Reserve Bank - at cost 4,776,850 2,736,750
Loans held for sale 474,880 1,262,667
Loans receivable - net of allowance for loan losses
of $2,572,799 and $2,314,074, respectively 217,740,153 197,449,282
Premises and equipment, net 5,580,189 5,736,395
Foreclosed real estate 706,764 716,014
Accrued interest receivable 1,318,318 1,042,453
Investment in bank owned life insurance 5,921,544 --
Other assets 3,146,247 3,025,431
------------ ------------
TOTAL ASSETS $351,729,992 $282,173,695
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Noninterest-bearing deposits 29,270,007 33,045,310
Interest-bearing deposits 198,284,561 169,979,802
------------ -----------
Total deposits 227,554,568 203,025,112
Short-term borrowings 31,191,285 752,298
Long-term debt 63,051,176 48,170,000
Accrued expenses and other liabilities 2,021,053 3,353,520
------------ -----------
Total liabilities 323,818,082 255,300,930
------------ -----------
STOCKHOLDERS' EQUITY:
Common stock - par value $.01; authorized - 15,000,000 shares;
issued 753,278 and 759,778 shares, respectively 7,533 7,598
Additional paid in capital 7,975,036 7,716,906
Retained earnings 20,071,630 18,817,615
Accumulated other comprehensive income (loss) (3,130) 493,691
Unearned ESOP shares (139,159) (163,045)
------------ -----------
Total stockholders' equity 27,911,910 26,872,765
------------ -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY 351,729,992 282,173,695
============ ===========
See notes to consolidated financial statements
4
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
2003 2002 2001
---- ---- ----
INTEREST INCOME:
Interest and fees on loans 13,411,904 14,221,247 15,223,463
Taxable interest and dividends on investment securities 2,688,451 2,388,095 3,172,515
Interest on deposits with banks and federal funds sold 64,570 104,646 76,049
---------- ---------- ----------
Total interest income 16,164,925 16,713,988 18,472,027
---------- ---------- ----------
INTEREST EXPENSE:
Interest on deposits 2,868,709 3,453,443 5,935,478
Interest on short term borrowings 2,731,983 7,634 259,558
Interest on long term debt 95,707 2,507,551 2,562,775
---------- ---------- ----------
Total interest expenses 5,696,399 5,968,628 8,757,811
---------- ---------- ----------
NET INTEREST INCOME 10,468,526 10,745,360 9,714,216
PROVISION FOR LOAN LOSSES 316,963 160,000 360,000
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 10,151,563 10,585,360 9,354,216
---------- ----------- ---------
NONINTEREST INCOME:
Loan appraisal, credit, and miscellaneous charges 261,387 179,006 226,641
Net gain on sale of loans held for sale 505,435 499,304 187,304
Income from bank owned life insurance 230,607 -- --
Service charges 695,128 1,041,662 953,496
Other 61,981 127,089 34,079
---------- ----------- ---------
Total noninterest income 1,754,538 1,847,061 1,401,520
---------- ----------- ---------
NONINTEREST EXPENSE:
Salary and employee benefits 4,702,181 4,228,050 3,827,491
Occupancy expense 750,567 831,148 689,575
Advertising 308,951 338,216 301,975
Data processing expense 403,967 568,095 291,399
Loss on disposal of obsolete equipment -- 65,104 --
Depreciation of furniture, fixtures, and equipment 507,236 339,184 263,535
Telephone communications 166,553 345,559 127,958
Valuation allowance on foreclosed real estate -- 972,889 --
ATM expenses 274,188 312,200 254,175
Office supplies 131,228 290,636 253,545
Office equipment expenses 129,849 247,171 211,316
Other 1,053,051 859,348 730,882
---------- ---------- ---------
Total noninterest expense 8,427,771 9,397,600 6,951,851
---------- ---------- ----------
INCOME BEFORE INCOME TAXES 3,478,330 3,034,821 3,803,885
Income tax expense 1,032,432 1,067,000 1,318,350
---------- ---------- ----------
NET INCOME 2,445,898 1,967,821 2,485,535
========== ========== ==========
INCOME PER COMMON SHARE
Basic $3.24 $2.58 $3.24
Diluted $3.07 $2.45 $3.11
Cash Dividend per Share $0.55 $0.50 $0.40
See notes to consolidated financial statements
5
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
Accumulated
Other Unearned
Common Paid-in Retained Comprehensive ESOP
Stock Capital Earnings Income (Loss) Shares Total
------ ------- -------- ------------- -------- -------
BALANCES, JANUARY 1, 2001 $ 7,777 $7,500,865 $16,175,708 $ (114,929) $(139,599) $23,429,822
Comprehensive income:
Net Income - - 2,485,535 - - 2,485,535
Unrealized gains on investment securities
net of tax of $343,599 - - - 670,442 - 670,442
-------
Total comprehensive income 3,155,977
Cash dividend $0.40 per share - - (309,204) - - (309,204)
Excess of fair market value over cost
of leveraged ESOP shares released - 12,964 - - - 12,964
Exercise of stock options 56 31,761 - - - 31,817
Repurchase of common stock (248) - (673,672) - - (673,920)
Net change in unearned ESOP shares (17) - - - (60,981) (60,998)
-------- ---------- ----------- ------------- --------- -----------
BALANCES, DECEMBER 31, 2001 7,568 7,545,590 17,678,367 555,513 (200,580) 25,586,458
Comprehensive income:
Net Income - - 1,967,821 - - 1,967,821
Unrealized losses on investment securities
net of tax of $24,455 - - - (61,822) - (61,822)
---------
Total comprehensive income 1,905,999
Cash dividend $0.50 per share - - (385,129) - - (385,129)
Excess of fair market value over cost
of leveraged ESOP shares released - 10,445 - - - 10,445
Exercise of stock options 133 160,871 - - - 161,004
Repurchase of common stock (123) - (443,444) (443,567)
Net change in unearned ESOP shares 20 - - - 37,535 37,555
--------- --------- ---------- --------- --------- ----------
BALANCES, DECEMBER 31, 2002 7,598 7,716,906 18,817,615 493,691 (163,045) 26,872,765
Comprehensive income:
Net Income - - 2,445,898 - - 2,445,898
Unrealized losses on investment securities
net of tax of $268,756 (496,821) (496,821)
---------
Total comprehensive income 1,949,077
Cash dividend $0.55 per share (422,361) (422,361)
Excess of fair market value over cost -
of leveraged ESOP shares released 39,533 39,533
Exercise of stock options 116 200,435 200,551
Repurchase of common stock (197) (769,522) (769,719)
Net change in unearned ESOP shares 16 23,886 23,902
Tax benefit for exercise of nonqualified
stock options 18,162 18,162
--------- --------- ---------- --------- --------- ----------
BALANCES, DECEMBER 31, 2003 $ 7,533 $7,975,036 $20,071,630 $ (3,130) $ (139,159) $27,911,910
========= ========= =========== ============ ========== ===========
See notes to consolidated financial statements
6
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECMBER 31, 2003, 2002, AND 2001
2003 2002 2001
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,445,898 $ 1,967,821 $ 2,485,535
Adjustments to reconcile net income to net
cash provided by operating activities:
Valuation allowance on foreclosed real estate -- 972,889
Provision for loan losses 316,963 160,000 360,000
Depreciation and amortization 663,134 445,558 396,400
Net amortization of premium/discount on
mortgage backed securities and investments 447,503 48,426 66,146
Deferred income tax benefit (22,219) (399,000) (205,000)
Increase in federal funds sold (574,660) (363,506)
(Increase) decrease in accrued interest receivable (275,865) 6,948 304,257
Decrease in deferred loan fees (17,849) (90,291) (18,131)
(Decrease) increase in accrued expenses and other liabilities (1,332,467) 562,539 638,249
Increase in other assets (51,385) (319,625) (1,006,157)
Loss (gain) on disposal of premises and equipment 12,241 76,315 (8,386)
Origination of loans held for sale (16,792,123) (23,376,262) (9,752,097)
Proceeds from sale of loans held for sale 18,085,345 24,967,214 11,938,716
Gain on sales of loans held for sale (505,435) (499,304) (187,304)
------------ ----------- -----------
Net cash provided by operating activities 2,399,081 4,159,722 5,012,228
------------ ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase (decrease) in interest-bearing deposits with banks 6,267,519 (7,501,693) (1,702,844)
Purchase of investment securities available for sale (65,726,882) (30,740,615) (2,246,225)
Proceeds from sale, redemption or principal payments
of investment securities available for sale 67,772,952 24,692,742 23,423,736
Purchase of investment securities held to maturity (64,384,597) (2,375,053) (1,345,703)
Proceeds from maturities or principal payments
of investment securities held to maturity 5,898,120 1,822,600 770,717
Net (purchase) redemption of FHLB and Federal Reserve stock (2,040,100) 298,800 --
Loans originated or acquired (172,289,356) (86,078,892) (96,149,353)
Principal collected on loans 151,699,369 82,009,912 70,448,931
Purchase of premises and equipment (528,169) (1,106,504) (1,334,396)
Proceeds from disposal of premises and equipment 9,000 281,084 8,963
Purchase of Bank owned life insurance policies (5,700,000) -- --
Sale (acquisition) of foreclosed real estate 9,250 333,484 (1,623,943)
------------ ------------ ----------
Net cash used in investing activities (79,012,894) (18,364,135) (9,750,117)
------------ ------------ ----------
7
TRI-COUNTY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
FOR THE YEARS ENDED DECMBER 31, 2003, 2002, AND 2001
2003 2002 2001
---- ---- ----
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits $ 24,529,456 $19,908,578 $15,310,535
Net increase (decrease) in short-term borrowings 30,438,987 (1,061,019) (11,737,586)
Dividends paid (422,361) (385,129) (309,204)
Exercise of stock options 218,713 161,004 31,817
Net change in unearned ESOP shares 63,435 47,999 (48,033)
Repurchase of common stock (769,719) (443,568) (673,920)
Proceeds from long-term borrowings 15,000,000 920,000 12,250,000
Payments of long-term borrowings (118,824) (1,400,000) (5,000,000)
-------------- ----------- -----------
Net cash provided by financing activities 68,939,687 17,747,865 9,823,609
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (7,674,126) 3,543,452 5,085,720
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 9,993,426 6,449,974 1,364,254
-------------- ----------- ----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 2,319,300 $ 9,993,426 $ 6,449,974
============== =========== ===========
Supplementary cash flow information: Cash paid during the year for:
Interest $ 5,647,280 $ 6,225,058 $ 9,015,483
Income taxes 1,715,369 2,110,500 1,431,000
Noncash transfer from loans to foreclosed real estate -- -- 1,276,070
See notes to consolidated financial statements.
8
TRI-COUNTY FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Consolidation
---------------------------------------
The consolidated financial statements include the accounts of Tri-County
Financial Corporation and its wholly owned subsidiary, Community Bank of
Tri-County (the "Bank") and the Bank's wholly owned subsidiaries, Tri-County
Investment Corporation and Community Mortgage Corporation of Tri-County
(collectively, the "Company"). All significant intercompany balances and
transactions have been eliminated in consolidation. The accounting and reporting
policies of the Company conform with accounting principles generally accepted in
the United States of America and to general practices within the banking
industry. Certain reclassifications have been made to amounts previously
reported to conform with classifications made in 2003.
Use of Estimates
----------------
In preparing consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the date of the balance sheet
and reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Material estimates that are
particularly susceptible to significant change in the near term relate to the
determination of the allowance for loan losses, and the valuation of foreclosed
real estate and deferred tax assets.
Nature of Operations
--------------------
The Company, through its bank subsidiary, conducts full service commercial
banking operations throughout the Southern Maryland area. Its primary financial
deposit products are savings, transaction, and term certificate accounts. Its
primary lending products are mortgage loans on residential, construction and
commercial real estate and various types of consumer and commercial lending.
Significant Group Concentrations of Credit
------------------------------------------
Most of the Company's activities take place in the Southern Maryland area
comprising St. Mary's, Charles, and Calvert counties. Note 2 discusses the types
of securities the Company invests in. Note 3 discusses the type of lending that
the Company engages in. The Company does not have any significant concentration
to any one customer or industry.
Cash and Cash Equivalents
-------------------------
For purposes of the consolidated statements of cash flows, the Company
considers all
9
highly liquid debt instruments with original maturities when purchased of three
months or less to be cash equivalents. These instruments are presented as cash
and due from banks.
Investment Securities
---------------------
Investments Trading -- Investment securities that are held principally for
resale in the near term are classified as trading assets and are recorded at
fair value with changes in fair value recorded in earnings. The Company had no
trading assets during the periods presented.
Investments Available-for-Sale -- Marketable equity securities and debt
securities not classified as held-to-maturity or trading are classified as
available-for-sale. Securities available-for-sale are acquired as part of the
Company's asset/liability management strategy and may be sold in response to
changes in interest rates, loan demand, changes in prepayment risk and other
factors. Securities available-for-sale are carried at fair value, with
unrealized gains or losses based on the difference between amortized cost and
fair value reported as accumulated other comprehensive income, a separate
component of stockholders' equity, net of deferred tax. Realized gains and
losses, using the specific identification method, are included as a separate
component of noninterest income. Related interest and dividends are included in
interest income. Declines in the fair value of individual available-for-sale
securities below their cost that are other than temporary result in write-downs
of the individual securities to their fair value. Factors affecting the
determination of whether an other-than-temporary impairment has occurred include
a downgrading of the security by a rating agency, a significant deterioration in
the financial condition of the issuer, or that management would not have the
intent and ability to hold a security for a period of time sufficient to allow
for any anticipated recovery in fair value.
Investments Held-to-Maturity and Other Equity Securities -- Investments
held-to-maturity are those securities which the Company has the ability and
positive intent to hold until maturity. Securities so classified at time of
purchase are recorded at cost. The carrying values of securities
held-to-maturity are adjusted for premium amortization and discount accretion.
Declines in the fair value of individual held-to-maturity securities below their
cost that are other than temporary result in write-downs of the individual
securities to their fair value. Factors affecting the determination of whether
an other than temporary impairment has occurred include a downgrading of the
security by the rating agency, a significant deterioration in the financial
condition of the issuer, or that management would not have the ability to hold a
security for a period of time sufficient to allow for any anticipated recovery
in fair value.
Investment in other equity securities represents Federal Reserve Bank and
Federal Home Loan Bank of Atlanta stock are recorded at cost and are considered
restricted as to marketability.
Loans Held for Sale
-------------------
Loans originated and intended for sale in the secondary market are carried
at the lower of cost or estimated fair value, in the aggregate. Net unrealized
losses, if any, are recognized through a valuation allowance by charges to
income.
Loans Receivable
----------------
The Company grants mortgage, commercial, and consumer loans to customers. A
10
substantial portion of the loan portfolio is represented by loans throughout
Southern Maryland. The ability of the Company's debtors to honor their contracts
is dependent upon the real estate and general economic conditions in this area.
Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff generally are reported at their
outstanding unpaid principal balances adjusted for charge-offs, the allowance
for loan losses, and any deferred fees or costs on originated loans. Interest
income is accrued on the unpaid principal balance. Loan origination fees, net of
certain direct origination costs, are deferred and recognized as an adjustment
of the related loan yield using the interest method.
The accrual of interest on mortgage and commercial loans is discontinued at
the time the loan is 90 days delinquent unless the credit is well secured and in
the process of collection. Consumer loans are charged-off no later than 120 days
past due. In all cases, loans are placed on nonaccrual or charged-off at an
earlier date if collection of principal or interest is considered doubtful.
All interest accrued but not collected from loans that are placed on
nonaccrual or charged-off is reversed against interest income. The interest on
these loans is accounted for on the cash-basis or cost-recovery method, until
qualifying for return to accrual. Loans are returned to accrual status when all
principal and interest amounts contractually due are brought current and future
payments are reasonably assured.
Allowance for Loan Losses
-------------------------
The allowance for loan losses is established as probable losses are
estimated to have occurred through a provision for loan losses charged to
earnings. Loan losses are charged against the allowance when management believes
that the uncollectibility of a loan balance is confirmed. Subsequent recoveries,
if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management
and is based upon management's periodic review of the collectibility of the
loans in light of historical experience, the nature and volume of the loan
portfolio, adverse situations that may affect the borrower's ability to repay,
estimated value of any underlying collateral and prevailing economic conditions.
This evaluation is inherently subjective as it requires estimates that are
susceptible to significant revision as more information becomes available.
The allowance for loan loss consists of a specific component and a
nonspecific component. The components of allowance for loan losses represent an
estimation done pursuant to either SFAS No. 5 "Accounting for Contingencies", or
SFAS No. 114 "Accounting by Creditors for Impairment of a Loan". The specific
component of the allowance for loan losses reflects expected losses resulting
from analysis developed through specific credit allocations for individual loans
and historical loss experience for each loan category. The specific credit
allocations are based on a regular analysis of all loans over a fixed-dollar
amount where the internal credit rating is at or below a predetermined
classification.
The nonspecific portion of the allowance is determined based on
management's assessment of general economic conditions, as well as specific
economic factors in the individual markets in which the Company operates. This
determination inherently involves a higher risk of uncertainty and considers
current risk factors that may not have yet manifested themselves in the
Company's historical loss factors used to determine the specific component of
the allowance and it recognizes knowledge of the portfolio may be incomplete.
The nonspecific allowance that is based upon historical loss factors, as
11
Foreclosed Real Estate
-----------------------
Assets acquired through, or in lieu of, loan foreclosure are held for sale
and are initially recorded at fair value at the date of foreclosure,
establishing a new cost basis. Subsequent to foreclosure, valuations are
periodically performed by management and the assets are carried at the lower of
carrying amount or fair value less cost to sell. Revenue and expenses from
operations and changes in the valuation allowance are included in noninterest
expense.
Transfers of Financial Assets
-----------------------------
Transfers of financial assets are accounted for as sales, when control over
the assets has been surrendered. Control over transferred assets is deemed to be
surrendered when (1) the assets have been isolated from the Company, (2) the
transferee obtains the right (free of conditions that constrain it from taking
advantage of that right) to pledge or exchange the transferred assets, and (3)
the Company does not maintain effective control over the transferred assets
through an agreement to repurchase them before their maturity.
Income Taxes
------------
The Company files a consolidated federal income tax return with its
subsidiaries. Deferred tax assets and liabilities are determined using the
liability (or balance sheet) method. Under this method, the net deferred tax
asset or liability is determined based on the tax effects of the temporary
differences between the book and tax bases of the various balance sheet assets
and liabilities and gives current recognition to changes in tax rates and laws.
Earnings Per Share
------------------
Basic earnings per common share represents income available to common
stockholders divided by the weighted average number of common shares outstanding
during the period. Diluted earnings per share reflects additional common shares
that would have been outstanding if potential dilutive common shares had been
issued, as well as any adjustment to income that would result from the assumed
issuance. Potential common shares that may be issued by the Company relate
solely to outstanding stock options, and are determined using the treasury stock
method.
Stock-Based Compensation
------------------------
Stock based compensation is recognized using the intrinsic value method.
For disclosure purposes, pro forma net income and earnings per share effects are
provided as if the fair value method had been applied.
The Company has a stock option and incentive plan to attract and retain
personnel and provide incentive to employees to promote the success of the
business. In addition, the Company has a stock option plan for its directors. At
December 31, 2003, 36,666 shares of stock have been authorized and are available
for grants of options under the plans. The exercise price for options granted is
set at the discretion of the Board of Directors, but is not less than the market
value of the shares as of the date of grant. An option's
13
maximum term is ten years and the options generally vest immediately upon
issuance.
The Company applies APB Opinion 25 and related Interpretations in
accounting for the stock option plan. Accordingly, no compensation cost has been
recognized. Had compensation cost for the Company's stock option plan been
determined based upon fair values at the grant dates for awards under the plan
consistent with the method prescribed by SFAS Nos. 123 and 148, the Company's
net income and earnings per share would have been adjusted to the pro forma
amounts indicated below:
2003 2002 2001
---- ---- ----
Net income, as reported $ 2,445,898 $1,967,821 $2,485,535
Less pro forma stock-based compensation expense
determined under the fair value method, net of related
tax effects (141,000) (217,187) (226,251)
------------- ---------- ----------
Pro forma net income $ 2,304,898 $1,750,634 $2,259,284
============= =========== ==========
Earnings per share as reported
Basic $ 3.24 $ 2.58 $ 3.24
Diluted 3.07 2.45 3.11
Pro forma earnings per share
Basic 3.05 2.30 2.95
Diluted 2.89 2.18 2.83
For the purpose of computing the pro forma amounts indicated above, the fair
value of each option on the date of grant is estimated using the Black-Scholes
option pricing model with the following weighted-average assumptions used for
the grants:
2003 2002 2001
---- ---- ----
Dividend Yield 2.17% 1.41% 1.30%
Expected volatility 17.24% 35.00% 15.00%
Risk - free interest rate 4.29% 4.82% 4.91%
Expected lives (in years) 10 10 10
Weighted average fair value $10.22 $17.24 $11.06
New Accounting Standards
- ------------------------
In April 2003, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities". SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities under SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities". The Statement is effective for contracts entered into
or modified after June 30, 2003 and for hedging relationships designated after
June 30, 2003. There was no material impact on the Company's financial condition
or results of operations upon adoption of this Statement.
In May 2003, the Financial Accounting Standards Board issued SFAS No. 150,
"Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity". SFAS No. 150
14
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both a liability and equity. It
requires that an issuer classify certain financial instruments as a liability,
although the financial instrument may previously have been classified as equity.
This Statement is effective for financial instruments entered into or modified
after May 31, 2003 and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003. There was no material impact on
the Company's financial condition or results of operations upon adoption of this
Statement.
In November 2002, the Financial Accounting Standards Board issued Interpretation
No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"), which
covers guarantees such as standby letters of credit, performance guarantees, and
direct or indirect guarantees of the indebtedness of others, but not guarantees
of funding. FIN 45 requires a guarantor to recognize, at the inception of a
guarantee, a liability in an amount equal to the fair value of the obligation
undertaken in issuing the guarantee, and requires disclosure about the maximum
potential payments that might be required, as well as the collateral or other
recourse obtainable. The recognition and measurement provisions of FIN 45 were
effective on a prospective basis after December 31, 2002, and its adoption by
the Company on January 1, 2003 has not had a significant effect on the Company's
consolidated financial statements.
2. INVESTMENT SECURITIES
The amortized cost and estimated fair values of securities with gross
unrealized losses and gains are:
December 31, 2003
-------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated Fair
Securities available for sale Cost Gains Losses Values
---- ----- ------ ------
Asset-backed securities issued by GSE's: $ 34,902,854 $ 102,973 $ 309,722 $ 34,696,105
------------- ---------- ---------- ------------
Total debt securities available for sale 34,902,854 102,973 309,722 34,696,105
Corporate equity securities 546,010 250,423 40,000 756,433
Bond mutual funds 2,845,950 -- 8,415 2,837,535
------------- ---------- ---------- ------------
Total securities available for sale $ 38,294,814 $ 353,396 $ 358,137 $ 38,290,074
============= ========== ========== ============
Securities held-to-maturity
Asset-backed securities issued by:
GSE's $ 50,067,413 $ 103,018 $ 646,379 $ 49,524,052
Other 7,284,039 -- -- 7,284,039
---------- ---------- ---------- ------------
Total debt securities held-to-maturity 57,351,452 103,018 646,379 56,808,091
U.S. Government obligations 300,000 -- 249 299,751
Other investments 3,953,723 157,750 -- 4,111,473
------------- ---------- ---------- ------------
Total securities held-to-maturity $ 61,605,175 $ 260,768 $ 646,628 $ 61,219,315
============= ========== ========== ============
December 31, 2002
-------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated Fair
Securities available for sale Cost Gains Losses Values
---- ----- ------ ------
Asset-backed securities issued by:
GSE's $ 28,597,630 $ 601,972 $ -- $ 29,199,602
Other 7,826,724 104,014 919 7,929,819
------------- ---------- -------- ------------
Total debt securities available for sale 36,424,354 705,986 919 37,129,421
Corporate equity securities 509,010 244,971 20,000 733,981
15
Bond mutual funds 3,962,711 -- -- 3,962,711
-------------- ---------- ---------- ------------
Total securities available for sale $ 40,896,075 $ 950,957 $ 20,919 $ 41,826,113
============== ========== ========== ============
Securities held-to-maturity
U.S. Government obligations $ 300,000 $ - $ 1,760 $ 298,240
Other investments 2,541,807 16,269 -- 2,558,076
-------------- ---------- ---------- ------------
Total securities held-to-maturity $ 2,841,807 $ 16,269 $ 1,760 $ 2,856,316
============== ========== ========== ============
Other investments consist of certain CD strip instruments whose market value is
estimated based on market returns on similar risk and maturity instruments
because no active market exists for these instruments. At December 31, 2003 and
2002, U.S. Government obligations with a carrying value of $300,000 were pledged
to secure public unit deposits and for other purposes required or permitted by
law. In addition, at December 31, 2003 and 2002, certain other securities with a
carrying value of $6,441,000 and $5,047,000, respectively were pledged to secure
certain deposits. At December 31, 2003, securities with a carrying value of
$68,500,000 were pledged as collateral for advances from the Federal Home Loan
Bank of Atlanta.
Gross unrealized losses and fair value by length of time that the individual
available-for-sale securities have been in a continuous unrealized loss position
at December 31, 2003 are as follows:
Continuous unrealized losses
existing for
------------------------------------------------------------
Total
Less than 12 More Than 12 unrealized
Fair Value months Months Losses
---------- ------------ ------------ ----------
Asset-backed securities issued by GSE's: $ 30,130,035 $ 309,722 $ -- $ 309,722
Corporate equity securities 500,000 -- 40,000 40,000
Bond mutual funds 2,837,535 8,415 -- 8,415
------------- --------- --------- ----------
$ 33,467,570 $ 318,137 $ 40,000 $ 358,137
============= ========= ========= ==========
The available-for-sale investment portfolio has a fair value of approximately
$38.3 million of which approximately $33.5 million of the securities have some
unrealized losses from their purchase price. Of these securities, $30.1million,
or 90%, are mortgage backed securities issued by GSE's, $2.8 million or 8.5% are
short duration mutual fund shares, and $500 thousand or 1.5% are equity
securities. The unrealized losses that exist in the mortgage backed securities
and mutual fund shares are the result of market changes in interest rates since
the original purchase.
The bond mutual fund shares have a modest duration and are backed by one year
adjustable rate mortgage backed securities. The asset backed securities have an
average duration of 3.3 years and are guaranteed by their issuer as to credit
risk. Total unrealized losses on these investments are minimal (approximately
1%). We believe that the losses in the equity securities are temporary.
Persistent losses may require a reevaluation of these losses. These factors
coupled with the fact the Company has both the intent and ability to hold these
investments for a period of time sufficient to allow for any anticipated
recovery in fair value substantiates that the unrealized losses in the
available-for-sale portfolio are temporary.
Gross unrealized losses and fair value by length of time that the individual
held-to-maturity securities have been in a continuous unrealized loss position
at December 31, 2003 are as follows:
16
Continuous unrealized losses
existing for
-------------------------------------------------------------
Less than 12 More Than 12 Total unrealized
Fair Value months Months Losses
---------- ------------ -------------- ---------------
Asset-backed securities issued by GSE's: $ 32,065,546 $ 646,379 -- $ 646,379
U.S. Government obligations 298,240 1,760 -- 1,760
Corporate equity securities -- -- -- --
------------ --------- -------- -----------
$ 32,363,786 $ 646,379 -- $ 648,139
============ ========= ======== ===========
The held-to-maturity investment portfolio has a fair value of approximately
$61.2 million of which approximately $32.4 million of the securities have some
unrealized losses from their purchase price. Of these securities, $32.1million,
or 99%, are mortgage backed securities issued by GSE's and the remainder is a
short duration U.S. Treasury note. The U.S.Treasury note will mature within
three months from the balance sheet date at full face value. The remaining asset
backed securities have a duration of approximately 5 years, are guaranteed as to
payment by the issuer, and have minimal losses compared to carrying value
(approximately 2%). The unrealized losses that exist are the result of market
changes in interest rates since the original purchase. These factors coupled
with the Company's intent and ability to hold these investments for a period of
time sufficient to allow for any anticipated recovery in fair value
substantiates that the unrealized losses in the held-to-maturity portfolio are
temporary.
The scheduled maturities of debt securities at December 31, 2003 are
as follows:
Available for Sale Held to Maturity
------------------------------------ -----------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
----------------- ------------------ ----------------- -----------------
Within one year $2,845,950 $2,837,535 $ 300,000 $ 299,751
Over one year through five years -- -- 3,953,723 4,111,473
Over five years through ten years -- -- -- --
---------- ------------- ----------- -----------
2,845,950 2,837,535 4,253,723 4,411,224
Mortgage-backed securities 34,902,854 34,696,105 57,351,452 56,808,091
----------- ------------- ----------- -----------
$37,748,804 $ 37,533,640 $61,605,175 $61,219,315
=========== ============= =========== ===========
There were no sales of investment securities available for sale during
2003, 2002, or 2001. Asset-backed securities are comprised of mortgage-backed
securities as well as mortgage derivative securities such as collateralized
mortgage obligations and real estate mortgage investment conduits. The Bank had
no holdings of private issuers in excess of 10% of capital at December 31, 2003.
17
3. LOANS RECEIVABLE
Loans receivable at December 31, 2003 and 2002 consist of the following:
2003 2002
---- ----
Commercial real estate $ 93,824,812 $ 74,291,593
Residential first mortgages 42,971,076 48,975,989
Residential construction 19,598,992 14,578,702
Second mortgage loans 19,561,771 19,007,265
Commercial lines of credit 30,435,729 29,947,327
Consumer loans 4,096,926 4,623,447
Commercial equipment 10,473,403 9,006,639
------------ ------------
220,962,709 200,430,961
------------ ------------
Less:
Deferred loan fees, net 649,756 667,605
Allowance for loan losses 2,572,799 2,314,074
------------ ------------
3,222,556 2,981,679
------------ ------------
$217,740,153 $197,449,282
============ ============
The following table sets forth the activity in the allowance for loan
losses:
2003 2002 2001
---- ---- ----
Balance January 1, $ 2,314,074 $2,281,581 $1,929,531
Add:
Provision charged to operations 316,963 160,000 360,000
Recoveries 2,446 2,795 31,417
Less:
Charge-offs 60,684 130,302 39,367
----------- --------- ----------
Balance, December 31 $ 2,572,799 2,314,074 $2,281,581
=========== ========= ==========
No loans included within the scope of SFAS No. 114 were identified as being
impaired at December 31, 2003 or 2002 and for the years then ended.
18
Loans on which the recognition of interest has been discontinued, which
were not included within the scope of SFAS No. 114, amounted to approximately
$380,000, $597,000, and $207,000 at December 31, 2003, 2002, and 2001,
respectively. If interest income had been recognized on nonaccrual loans at
their stated rates during 2003, 2002, and 2001, interest income would have been
increased by approximately $11,626, $33,320, and $10,480 respectively. Income in
the amount of $29,066 was recognized on these loans in 2003. No income was
recognized for these loans in 2002 and 2001, respectively.
Included in loans receivable at December 31, 2003 and 2002, is $593,452 and
$1,022,846 due from officers and directors of the Bank. These loans are made in
the ordinary course of business at substantially the same terms and conditions
as those prevailing at the time for comparable transactions with outsiders and
are not considered to involve more than the normal risk of collectibility.
Activity in loans outstanding to officers and directors is summarized as
follows:
2003 2002
---- ----
Balance, beginning of year $1,022,846 $1,223,840
New loans made during year 528,106 60,001
Repayments made during year (931,108) (260,995)
Reductions due to change in directors (26,392) --
--------- ---------
Balance, end of year $ 593,452 $1,022,846
========== ==========
19
4. LOAN SERVICING
Loans serviced for others and not reflected in the balance sheets are
$54,660,488 and $73,205,838 at December 31, 2003 and 2002, respectively.
Servicing loans for others generally consists of collecting mortgage payments,
maintaining escrow accounts, disbursing payments to investors and foreclosure
processing. Loan servicing income is recorded on the accrual basis and includes
servicing fees from investors and certain charges collected from borrowers, such
as late payment fees. The following table presents the activity of the mortgage
servicing rights ("MSR").
Year Ended December 31,
------------------------------------------------
2003 2002 2001
---- ---- ----
Balance at beginning of the year $ 780,408 $ 525,075 $ 486,956
Additions 284,327 303,333 182,119
Amortization (177,795) (48,000) (144,000)
Application of valuation allowance to permanentlty impaired
MSR's (210,000) -- --
--------- ------------ -------------
676,940 $ 780,408 $ 525,075
========= ============ =============
Valuation allowance for impairment
Balance at beginning of the year $ -- -- --
Additions 210,000 -- --
Application of valuation allowance to
permanentlty impaired MSR's (210,000) -- --
--------- ------------ -------------
$ - -- --
========= ============ =============
5. FORECLOSED ASSETS
Foreclosed assets are presented net of an allowance for losses. An analysis
of the allowance for losses on foreclosed assets is as follows:
Years ended December 31,
------------------------------------------------------
2003 2002 2001
---- ---- ----
Balance at beginning of year $ 972,899 $ - $ -
Provision for losses - 972,899 -
Charge-offs - - -
Recoveries - - -
---------- ---------- -----
Balance at end of year $ 972,899 $ 972,899 $ -
========== ========== =====
20
Expenses applicable to foreclosed assets include the following:
Years ended December 31,
----------------------------------------------
2003 2002 2001
---- ---- ----
Net gain on sale of foreclosed real estate $ -- $ (64,755) $ --
Provision for losses -- 972,889 --
Operating expenses 10,153 12,176 6,253
--------------- ---------- -------
$ 10,153 $ 920,310 $ 6,253
=============== ========== =======
6. PREMISES AND EQUIPMENT
A summary of premises and equipment at December 31, 2003 and 2002 is as
follows:
2003 2002
---- ----
Land $ 1,368,077 $ 1,399,311
Building and improvements 4,619,671 4,322,963
Furniture and equipment 2,574,424 2,367,380
Automobiles 124,388 111,881
---------------- ---------------
Total cost 8,686,560 8,201,535
Less accumulated depreciation 3,106,371 2,465,141
---------------- --------------
Premises and equipment, net $ 5,580,189 $ 5,736,394
=============== ==============
Certain bank facilities are leased under various operating leases. Rent
expense was $197,157, $211,200, and $242,387 in 2003, 2002 and 2001,
respectively. Future minimum rental commitments under noncancellable operating
leases are as follows:
2004 $ 181,362
2005 180,912
2005 180,462
2006 179,562
2007 113,112
Thereafter 192,000
----------
Total $1,027,410
==========
21
7. DEPOSITS
Deposits at December 31 consist of:
2003 2002
---- ----
Noninterest-bearing demand $ 29,270,007 $ 33,045,310
Interest-bearing:
Demand 29,674,110 22,440,453
Money market deposits 44,473,200 39,781,718
Savings 34,670,884 30,675,167
Certificates of deposit 89,466,367 77,082,464
----------- -----------
Total interest-bearing 198,284,561 169,979,801
------------ -----------
Total deposits $ 227,554,568 $ 203,025,112
============== =============
The aggregate amount of time deposits in denominations of $100,000 or more
at December 31, 2003 and 2002 were $26,869,000 and $18,790,000, respectively.
At December 31, 2003, the scheduled maturities of time deposits are as follows
(in 000's):
2004 $57,597
2005 14,386
2006 4,153
2007 8,293
2008 5,039
---------
$89,466
22
8. SHORT TERM BORROWINGS AND LONG-TERM DEBT
The Bank's long-term debt consists of advances from the Federal Home Loan
Bank of Atlanta. The Bank classifies debt based upon original maturity, and does
not reclassify debt to short term status during its life. These include fixed
rate, adjustable rate, and convertible advances. Rates and maturities on these
advances are as follows:
Fixed Adjustable Fixed Rate
Rate Rate Convertible
----- ----------- -----------
2003
Highest rate 5.43% 1.96% 6.25%
Lowest rate 1.00% 1.96% 3.27%
Weighted average rate 3.94% 1.96% 5.15%
Matures through 2022 2005 2011
2002
Highest rate 5.43% 2.49% 6.25%
Lowest rate 1.00% 2.49% 4.62%
Weighted average rate 4.69% 2.49% 5.42%
Matures through 2022 2005 2011
The Bank's fixed rate debt generally consists of advances with monthly
interest payments and principal due at maturity. The Bank's adjustable rate
long-term debt adjusts quarterly based upon a margin over the three month London
Interbank Offered Rate ("LIBOR"). The margin is set at 80 basis points. The debt
has a minimum interest of .80% and a maximum rate of 5.30%. The Bank's fixed
rate, convertible, long-term debt is callable by the issuer, after an initial
period ranging from six months to five years. These advances become callable on
dates ranging from 2004 to 2005. Depending on the specific instrument, the
instrument is callable either continuously after the initial period (Bermuda
option) or only at the date ending the initial period (European). The
contractual maturities of long-term debt are as follows:
December 31,
2003 2002
---------------------------------------------------------------------------- ------------
Fixed Adjustable Fixed Rate
Rate Rate Convertible Total Total
----- ---------- ----------- ----- -----
Due in 2004 $ 88,000 $ -- $ -- $ 88,000 $ 88,000
Due in 2005 74,000 5,000,000 10,000,000 15,074,000 15,074,000
Due in 2006 12,000,000 -- -- 12,000,000 7,000,000
Due in 2007 5,000,000 -- -- 5,000,000 --
Due in 2008 -- -- -- -- --
Thereafter 889,176 -- 30,000,000 30,889,176 25,920,000
----------- ---------- ------------ ------------ -----------
$18,051,176 $5,000,000 $ 40,000,000 $ 63,051,176 $48,082,000
=========== ========== ============ ============ ===========
23
From time to time, the Bank also has daily advances outstanding, which are
classified as short-term debt. These advances are repayable at the Bank's option
at any time and reprice daily. These advances totaled $31,000,000 and $0 at
December 31, 2003 and 2002, respectively. The rate on the short term debt at
December 31, 2003 was 1.15%.
Under the terms of an Agreement for Advances and Security Agreement with
Blanket Floating Lien (the "Agreement"), the Company maintains eligible
collateral consisting of 1 - 4 unit residential first mortgage loans, discounted
at 75% of the unpaid principal balance, equal to 100% at December 31, 2003, of
its total outstanding long and short term Federal Home Loan Bank advances.
During 2002 and 2003, the Bank entered into addendums to the Agreement that
expanded the types of eligible collateral under the Agreement to include certain
commercial real estate and second mortgage loans. These loans are subject to
eligibility rules, and collateral values are discounted at 50% of the unpaid
loan principal balance. In addition, only 50% of total collateral for Federal
Home Loan Bank advances may consist of commercial real estate loans. In addition
the Bank has pledged its Federal Home Loan Bank stock of $4,702,600 and
securities with a carrying value of $68,500,000 as additional collateral for its
advances. Based upon our understanding of current borrowing rules at the Federal
Home Loan Bank of Atlanta, the Bank is limited to total advances of up to 35% of
assets or $123 million. The Bank had sufficient collateral to borrow this
amount.
Other short-term debt consists of notes payable to the U.S. Treasury, which
are Federal treasury tax and loan deposits accepted by the Bank and remitted on
demand to the Federal Reserve Bank. At December 31, 2003 and 2002, such
borrowings were $191,285 and $752,298, respectively. The Bank pays interest on
these balances at a slight discount to the federal funds rate. The notes are
secured by investment securities with an amortized cost of approximately
$5,948,600 and $786,700 at December 31, 2003 and 2002, respectively.
9. INCOME TAXES
Income tax expense is summarized as follows:
2003 2002 2001
---- ---- ----
Current
Federal $ 961,686 $ 1,312,000 $ 1,409,350
State 92,965 154,000 114,000
-------------- ----------------- ----------------
1,054,651 1,466,000 1,523,350
-------------- ----------------- ----------------
Deferred
Federal (19,561) (327,000) (168,000)
State (2,658) (72,000) (37,000)
-------------- ----------------- ----------------
(22,219) (399,000) (205,000)
-------------- ----------------- ----------------
Total Income Tax Expense $ 1,032,432 $ 1,067,000 $ 1,318,350
============== ================= ================
24
Total income tax expense differed from the amounts computed by applying the
federal income tax rate of 34% to income before income taxes as a result of the
following:
2003 2002 2001
---- ---- ----
Percent Percent
Percent of of Pre of Pre
Pre Tax Tax Tax
Amount Income Amount Income Amount Income
------ ------ ------ ------ ------ ------
Expected income tax expense at
federal tax rate $ 1,182,632 34.0% $ 1,031,839 34.0% $1,293,321 34.0%
State taxes net of federal benefit 59,603 1.7% 61,666 2.0% 77,000 2.0%
Nondeductible expenses 14,130 0.4% 20,908 0.7% 5,233 0.1%
Nontaxable income (213,613) -6.1% (109,198) -3.6% (34,716) -0.9%
Other (10,320) -0.3% 61,785 2.0% (22,488) -0.6%
----------- ---- ------------- ---- ---------- -----
$ 1,032,432 29.7% $ 1,067,000 35.2% $1,318,350 34.7%
=========== ==== ============= ===== ========== =====
The net deferred tax assets in the accompanying balance sheets include the
following components:
2003 2002
---- ----
Deferred tax assets:
Deferred fees $ 9,612 $ 22,147
Allowance for loan losses 960,130 795,953
Deferred compensation 152,838 118,709
Valuation allowance on foreclosed real estate 375,730 375,730
Unrealized loss on investment
securities available for sale 1,612 --
------------ -----------
1,499,922 1,312,539
------------ -----------
Deferred tax liabilities:
FHLB stock dividends 152,896 152,896
Depreciation 261,057 97,505
Unrealized gain on investment
securities available for sale -- 267,144
------------ ------------
413,953 517,545
------------ ------------
$ 1,085,969 $ 794,994
============ ============
Retained earnings at December 31, 2003, includes approximately $1.2
million of bad debt deductions allowed for federal income tax purposes (the
"base year tax reserve") for which no deferred
25
income tax has been recognized. If, in the future, this portion of retained
earnings is used for any purpose other than to absorb bad debt losses, it would
create income for tax purposes only and income taxes would be imposed at the
then prevailing rates. The unrecorded income tax liability on the above amount
was approximately $753,479 at December 31, 2003.
Prior to January 1, 1996, the Bank computed its tax bad debt deduction
based upon the percentage of taxable income method as defined by the Internal
Revenue Code. The bad debt deduction allowable under this method equaled 8% of
taxable income determined without regard to the bad debt deduction and with
certain adjustments. The tax bad debt deduction differed from the bad debt
expense used for financial accounting purposes.
In August 1996, the Small Business Job Protection Act (the "Act") repealed
the percentage of taxable income method of accounting for bad debts effective
for years beginning after December 31, 1995. The Act required the Bank to change
its method of computing reserves for bad debts to the experience method. This
method is available to banks with assets less than $500 million and allows the
Bank to maintain a tax reserve for bad debts and to take bad debt deductions for
reasonable additions to the reserve. As a result of this change, the Bank has to
recapture into income a portion of its existing tax bad debt reserve. This
recapture occurs ratably over a six-taxable year period, beginning with the 1998
tax year. For financial reporting purposes, this recapture does not result in
additional tax expense as the Bank adequately provided deferred taxes in prior
years. Furthermore, this change does not require the Bank to recapture its base
year tax reserve.
10. COMMITMENTS AND CONTINGENCIES
The Bank is party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments are commitments to extend credit. These instruments
may, but do not necessarily, involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the balance sheets. The
Bank's exposure to credit loss in the event of nonperformance by the other party
to the financial instrument is represented by the contractual amount of those
instruments. The Bank uses the same credit policies in making commitments as it
does for on-balance-sheet loans receivable.
As of December 31, 2003 and 2002, in addition to the undisbursed portion of
loans receivable of approximately $8,907,000 and $6,031,000, respectively, the
Bank had outstanding loan commitments approximating $2,871,000 and $1,927,000,
respectively.
Standby letters of credit written are conditional commitments issued by the
Bank to guarantee the performance of a customer to a third party. These
guarantees are issued primarily to support construction borrowing arrangements.
The credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loan facilities to customers. The Bank holds cash or
a secured interest in real estate as collateral to support those commitments for
which collateral is deemed necessary. Standby letters of credit outstanding
amounted to $9,538,000 and $5,698,000 at December 31, 2003 and 2002,
respectively. In addition to the commitments noted above, customers had
approximately $28,600,000 and $10,100,000 available under lines of credit at
December 31, 2003 and 2002, respectively.
26
11. STOCK OPTION AND INCENTIVE PLAN
The Company has a stock option and incentive plan to attract and retain
personnel and provide incentive to employees to promote the success of the
business. In addition, the Company has a stock option plan for its directors. At
December 31, 2003, 36,666 shares of stock have been authorized and are available
for grants of options under the plans. The exercise price for options granted is
set at the discretion of the Board of Directors, but is not less than the market
value of the shares as of the date of grant. An option's maximum term is ten
years and the options generally vest immediately upon issuance.
The following tables summarize activity in the plan:
2003 2002 2001
----------------------- ----------------------- ----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
----------- ----------- ---------- ------------ --------- ------------
Outstanding at beginning of year 97,601 $21.46 99,679 $18.99 91,036 $16.89
Granted 16,815 41.46 12,595 31.67 20,448 26.57
Exercised (11,620) 17.23 (14,078) 12.92 (7,105) 10.28
Forfeitures -- -- (595) 26.26 (4,700) 24.41
------- ------ ------- ------ ------- ------
Outstanding at end of year 102,796 $25.21 97,601 $21.46 99,679 $18.99
======= ====== ======= ====== ======= ======
Options outstanding are all currently exercisable and are summarized as follows:
Weighted
Average Weighted
Number Remaining Average
Outstanding Contractual Exercise
December 31, 2003 Life Price
----------------- ----------- ----------
25,167 2 years $10.28
19,246 5 years 24.23
7,624 6 years 26.60
14,732 7 years 26.65
14,250 8 years 26.70
7,976 9 years 39.00
13,801 10 years 42.00
------ -----
102,796 $25.21
======= ======
12. EMPLOYEE BENEFIT PLANS
The Bank has an Employee Stock Ownership Plan (ESOP) which covers
substantially all of the
27
Bank's employees. The ESOP acquires stock of the Bank's parent corporation,
Tri-County Financial Corporation. The Company accounts for its ESOP in
accordance with AICPA Statement of Position 93-6. Accordingly, unencumbered
shares held by the ESOP are treated as outstanding in computing earnings per
share. Shares issued to the ESOP but pledged as collateral for loans obtained to
provide funds to acquire the shares are not treated as outstanding in computing
earnings per share. Dividends on ESOP shares are recorded as a reduction of
retained earnings. The ESOP may acquire in the open market up to 195,700 shares.
At December 31, 2003, the Plan owns 55,929 shares.
The Company also has a 401(k) plan. The Bank matches a portion of the
employee contributions. This ratio is determined annually by the Board of
Directors. During 2001 and 2002 one-half of an employee's first 6% deferral was
matched. In 2003, the Company matched one-half of the employee's first 8%
deferral. All employees who have completed one year of service and have reached
the age of 21 are covered under this defined contribution plan. Contributions
are determined at the discretion of management and the Board of Directors. For
the years ended December 31, 2003, 2002, and 2001, the Company charged $81,000,
$108,000, and $93,000, against earnings to fund the Plans.
In addition, the Bank has a separate nonqualified retirement plan for
non-employee directors. Directors are eligible for a maximum benefit of $3,500 a
year for ten years following retirement from the Board of Community Bank of Tri
County. The maximum benefit is earned at 15 years of service as a non-employee
director. Full vesting occurs after 2 years of service. Expense recorded for
this plan was $24,000, $11,000, and $7,000 for the years ending December 31,
2003, 2002, and 2001 respectively.
13. REGULATORY MATTERS
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal and state banking agencies. Failure to
meet minimum capital requirements can initiate certain mandatory and possible
additional discretionary actions by regulators that, if undertaken, could have a
direct material effect on the Company's and the Bank's financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Bank must meet specific capital guidelines that involve
quantitative measures of the Bank's assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting practices. The
Bank's capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the table below) of tangible and core capital (as defined in the
regulations) to total adjusted assets (as defined), and of risk-based capital
(as defined) to risk-weighted assets (as defined). Management believes, as of
December 31, 2003, that the Company and the Bank meet all capital adequacy
requirements to which they are subject.
As of December 31, 2003, the most recent notification from the Federal
Reserve categorized the Bank as well-capitalized under the regulatory framework
for prompt corrective action. To be categorized as well-capitalized, the Bank
must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage
ratios as set forth in the table. There are no conditions or events since that
notification that management believes have changed the Company's or the Bank's
category.
28
The Company's and the Bank's actual capital amounts and ratios for 2003 and
2002 are presented in the tables below:
To be considered well
capitalized under
Required for capital prompt
Actual adequacy purposes corrective action
------ ----------------- -----------------
At December 31, 2003
Total capital (to risk weighted
assets)
The Company 30,488 12.20% $ 19,992 8.00%
The Bank 29,193 11.73% $ 19,912 8.00% $ 24,890 10.00%
Tier 1capital (to risk weighted
assets)
The Company 27,915 11.17% 9,996 4.00%
The Bank 26,630 10.70% 9,956 4.00% $ 14,934 6.00%
Tier 1capital (to average assets)
The Company 27,915 8.04% 13,881 4.00%
The Bank 26,630 7.70% 13,841 4.00% $ 17,302 5.00%
At December 31, 2002
Total capital (to risk weighted
assets)
The Company 28,769 13.77% 16,715 8.00%
The Bank 26,966 12.96% 16,647 8.00% $ 20,809 10.00%
Tier 1 capital (to risk weighted
assets)
The Company 26,379 12.63% 8,357 4.00%
The Bank 24,576 11.81% 5,324 4.00% $ 12,485 6.00%
Tier 1capital (to average assets)
The Company 26,379 9.53% 11,069 4.00%
The Bank 24,576 8.96% 10,966 4.00% $ 13,708 5.00%
14. EARNINGS PER SHARE
The calculations of basic and diluted earnings per share are as
follows:
2003 2002 2001
---------------- ----------------- ----------------
Basic earnings per share
Net income $ 2,445,898 $ 1,967,821 $ 2,485,535
Average common shares outstanding 754,044 761,417 766,927
Net income per common share - basic $ 3.24 $ 2.58 $ 3.24
Diluted earnings per share
Net income $ 2,445,898 $ 1,967,821 $ 2,485,535
Average common shares outstanding 754,044 761,417 766,927
Stock option adjustment 41,977 42,705 31,860
Average common shares outstanding - diluted 796,021 804,122 798,787
Net income per common share - diluted $ 3.07 $ 2.45 $ 3.11
No antidilutive options were outstanding at December 31, 2003 or 2001. At
December 31,2002, 4,962
29
antidilutive options were excluded from the calculation.
15. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value amounts have been determined by the Company using
available market information and appropriate valuation methodologies. However,
considerable judgment is necessarily required to interpret market data to
develop the estimates of fair value. Accordingly, the estimates presented herein
are not necessarily indicative of the amounts the Company could realize in a
current market exchange. The use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated fair value
amounts. Therefore, any aggregate unrealized gains or losses should not be
interpreted as a forecast of future earnings or cash flows. Furthermore, the
fair values disclosed should not be interpreted as the aggregate current value
of the Company.
December 31, 2003 December 31, 2002
----------------- -----------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- --------- -------- ---------
Assets:
Cash and cash equivalents $ 2,319,300 $ 2,319,300 $ 9,993,426 $ 9,933,426
Interest bearing deposits with banks 8,912,332 8,912,332 15,179,851 15,179,851
Federal funds sold 938,166 938,166 363,506 363,506
Investment securities and stock in FHLB
and FRB 104,672,099 104,281,498 47,404,670 47,419,179
Loans receivable, net 217,740,153 226,213,642 197,449,282 200,839,805
Loans held for sale 474,880 482,003 1,262,667 1,287,920
Liabilities:
Savings, NOW, and money market accounts 138,088,201 138,088,201 125,942,648 125,942,648
Time certificates 89,466,367 91,095,780 77,082,464 78,811,495
Long-term debt and other borrowed funds 94,242,461 97,940,064 48,922,298 53,801,600
At December 31, 2003 and 2002, the Company had outstanding loan commitments
and standby letters of credit of $12.4 million and $13.1 million, respectively.
Based on the short-term lives of these instruments, the Company does not believe
that the fair value of these instruments differs significantly from their
carrying values.
Valuation Methodology
- ---------------------
Cash and Cash Equivalents - For cash and cash equivalents, the carrying
amount is a reasonable estimate of fair value.
Investment Securities - Fair values are based on quoted market prices or
dealer quotes. If a quoted market price is not available, fair value is
estimated using quoted market prices for similar securities.
Mortgage-Backed Securities - Fair values are based on quoted market prices
or dealer quotes. If a quoted market price is not available, fair value is
estimated using quoted market prices for similar securities.
30
Loans Receivable and Loans Held for Sale - For conforming residential
first-mortgage loans, the market price for loans with similar coupons and
maturities was used. For nonconforming loans with maturities similar to
conforming loans, the coupon was adjusted for credit risk. Loans which did not
have quoted market prices were priced using the discounted cash flow method. The
discount rate used was the rate currently offered on similar products. Loans
priced using the discounted cash flow method included residential construction
loans, commercial real estate loans, and consumer loans. The estimated fair
value of loans held for sale is based on the terms of the related sale
commitments.
Deposits - The fair value of checking accounts, saving accounts, and money
market accounts was the amount payable on demand at the reporting date.
Time Certificates - The fair value was determined using the discounted cash
flow method. The discount rate was equal to the rate currently offered on
similar products.
Long-Term Debt and Other Borrowed Funds - These were valued using the
discounted cash flow method. The discount rate was equal to the rate currently
offered on similar borrowings.
Off-Balance sheet instruments - The Company charges fees for commitments to
extend credit. Interest rates on loans for which these commitments are extended
are normally committed for periods of less than one month. Fees charged on
standby letters of credit and other financial guarantees are deemed to be
immaterial and these guarantees are expected to be settled at face amount or
expire unused. It is impractical to assign any fair value to these commitments.
The fair value estimates presented herein are based on pertinent
information available to management as of December 31, 2003 and 2002. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial statements since that date and,
therefore, current estimates of fair value may differ significantly from the
amount presented herein.
31
16. CONDENSED FINANCIAL STATEMENTS - PARENT COMPANY ONLY
Financial information pertaining only to Tri-County Financial Corporation is as
follows:
Balance Sheets
ASSETS
2003 2002
---- ----
Cash-noninterest bearing $ 298,364 $ 301,927
Cash-interest bearing 255,108 838,142
Investment securities available for sale 33,152 32,436
Investment in wholly owned subsidiary 26,627,098 25,069,624
Other assets 957,544 884,984
----------- -----------
TOTAL ASSETS $28,171,266 $27,127,113
=========== ===========
Other liabilities $ 259,356 $ 254,348
Stockholders' equity
Common stock 7,533 7,598
Surplus 7,975,036 7,716,906
Retained earnings 20,071,630 18,817,615
Total accumulated other comprehensive income (loss) (3,130) 493,691
Unearned ESOP shares (139,159) (163,045)
------------- ------------
Total stockholders' equity 27,911,910 26,872,765
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 28,171,266 $ 27,127,113
============= ============
CONDENSED STATEMENTS OF INCOME:
-------------------------------------------------------------
Year Ended December 31,
-------------------------------------------------------------
2003 2002 2001
---- ---- ----
Dividends from subsidiary $ 500,000 $ 1,000,000 $ 2,250,000
Interest income 10,356 18,644 26,929
Miscellaneous expenses (174,595) (154,995) (167,787)
------------ ------------- ------------
Income before income taxes and equity in 335,761 863,649 2,109,142
undistributed net income of subsidiary
Federal and state income tax benefit 55,841 46,000 40,650
Equity in undistributed net income of subsidiary 2,054,296 1,058,172 335,743
------------ ------------- ------------
NET INCOME $ 2,445,898 $ 1,967,821 $ 2,485,535
============= ============= ============
32
Condensed Statements of Cash Flows:
Year Ended December 31,
--------------------------------------------------
2003 2002 2001
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,445,898 $ 1,967,821 $2,485,535
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed earnings of subsidiary (2,054,296) (1,058,172) (335,743)
Increase in current assets (72,560) (147,776) (611,564)
Increase in current liabilities 5,008 14,222 3,600
------------ ----------- ----------
Net cash provided by operating activities 324,050 730,095 1,541,828
------------ ----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease (increase) in interest-bearing deposits 583,034 87,379 (645,521)
Purchase of investment securities available for sale (714) -- (76,903)
Maturity or redemption of investment securities
available for sale -- 79,146 --
------------ ----------- ----------
Net cash provided (used) by investing activities 582,320 166,525 (722,424)
------------ ----------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends paid (422,361) (385,129) (309,204)
Exercise of stock options 218,713 161,004 31,817
Net change in ESOP loan 63,435 48,000 (48,034)
Redemption of common stock (769,720) (443,568) (673,920)
------------ ----------- ----------
Net cash used in financing activities (909,933) (619,693) (999,341)
------------ ----------- ----------
(DECREASE) INCREASE IN CASH (3,563) 276,927 (179,937)
CASH AT BEGINNING OF YEAR 301,927 25,000 204,937
------------ ----------- ----------
CASH AT END OF YEAR $ 298,364 $ 301,927 $ 25,000
============ =========== ==========
33
17. QUARTERLY FINANCIAL RESULTS (UNAUDITED)
A summary of selected consolidated quarterly financial data for the two
years ended December 31, 2003 is reported as follows:
2003
---------------------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Interest and dividend income $4,112,111 $4,210,624 $3,923,796 $3,918,384
Interest expense 1,524,537 1,431,824 1,378,744 1,361,294
---------- ---------- ---------- ----------
Net interest income 2,587,574 2,778,800 2,545,052 2,557,090
Provision for loan loss 171,623 31,013 108,941 5,386
---------- ---------- ---------- ----------
Net interest income after provision 2,415,951 2,747,787 2,436,111 2,551,704
Noninterest income 580,039 332,762 453,793 387,954
Noninterest expense 2,163,566 2,190,164 2,125,494 1,948,547
Income before income taxes 832,424 890,385 764,410 991,111
Provision for income taxes 133,667 293,550 255,215 350,000
Net income $ 698,757 $ 596,835 $ 509,195 $ 641,111
========== ========= ========= =========
Earnings per common share
Basic 0.93 0.79 0.68 0.84
===== ===== ===== =====
Diluted 0.87 0.75 0.65 0.80
===== ===== ===== =====
2002
---------------------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Interest and dividend income $4,057,309 $4,281,934 $4,207,146 $4,167,599
Interest expense 1,438,465 1,484,376 1,495,799 1,549,988
---------- ---------- ---------- ----------
Net interest income 2,618,844 2,797,558 2,711,347 2,617,611
Provision for loan loss 30,000 30,000 30,000 70,000
---------- ---------- ---------- ----------
Net interest income after provision 2,588,844 2,767,558 2,681,347 2,547,611
Noninterest income 713,006 386,913 349,793 397,349
Noninterest expense 2,025,764 2,033,746 3,408,796 1,929,294
Income before income taxes 1,276,086 1,120,725 (377,656) 1,015,666
Provision for income taxes 446,000 391,000 (134,600) 364,600
---------- ---------- ---------- ----------
Net income $ 830,086 $ 729,725 $(243,056) $ 651,066
========== ========== =========== ==========
Earnings per common share
Basic 1.09 0.96 (0.32) 0.86
===== ===== ====== =====
Diluted 1.03 0.91 (0.32) 0.82
===== ===== ====== =====
34
TRI-COUNTY FINANCIAL CORPORATION
CORPORATE INFORMATION: Tri-County Financial Corporation
Community Bank of Tri-County
- --------------------------------------------------------------------------------
DIRECTORS OF BOTH
Michael L. Middleton
Chairman of the Board
C. Marie Brown James R. Shepherd Louis P. Jenkins, Jr.
Herbert N. Redmond, Jr. A. Joseph Slater, Jr. H. Beaman Smith
- --------------------------------------------------------------------------------
OFFICERS OF COMMUNITY BANK OF TRI-COUNTY
Michael L. Middleton
President and Chief Executive Officer
C. Marie Brown Gregory C. Cockerham William J. Pasenelli
Executive Vice President Executive Vice President Executive Vice
Chief Operating Officer Chief Lending Officer President Chief
Chief Financial Officer
David D. Vaira John H. Buckmaster Paige Watkins H. Beaman Smith
Senior Vice President Vice President Vice President Secretary/Treasurer
- --------------------------------------------------------------------------------
COUNSEL
Corporate: Local Counsel:
Semmes, Bowen & Semmes Louis P. Jenkins, Esq.
250 West Pratt Street P.O. Box 280
Baltimore, Maryland 21201 La Plata, Maryland 20646
(410) 539-5040 (301) 934-9571
Special Counsel: Auditors:
Gary R. Bronstein, Esq. Stegman & Company
Muldoon Murphy Faucette & Aguggia LLP 405 East Joppa Road, Suite 200
5101 Wisconsin Avenue, NW, Suite 500 Baltimore, Maryland 21286
Washington, DC 20016 (410) 823-8000
(202) 362-0840
FORM 10-K
A copy of Form 10-K, including financial statements as filed with the Securities
and Exchange Commission will be furnished without charge to stockholders as of
the record date upon written request to H. Beaman Smith, Secretary, Tri-County
Financial Corporation, P.O. Box 38, Waldorf, Maryland 20604.
STOCK TRANSFER AGENT: STOCK TRANSACTIONS AND INQUIRIES:
The Bank of New York Christy Lombardi
Shareholder Relations Dept. Community Bank of Tri-County
P.O. Box 11258 P.O. Box 38
Church Street Station Waldorf, Maryland 20604
New York, New York 10286 1-888-745-BANK, ext.1037
1-800-524-4458 Fax (301) 885-1437
http://www.stockbny.com clombardi@cbtc.com
ANNUAL MEETING:
May 5, 2004, 10:00 a.m.
Community Bank of Tri-County
2nd Floor Board Room
3035 Leonardtown Road
Waldorf, Maryland
Main Office St. Patrick's Drive Branch
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3035 Leonardtown Road 20 St. Patrick's Drive
P.O. Box 38 Waldorf, MD 20603
Waldorf, MD 20604 301.932.4424
301.645.5601
Bryans Road Branch Charlotte Hall Branch
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8010 Matthews Road 30165 Three Notch Road
P.O. Box 522 P.O. Box 472
Bryans Road, MD 20616 Charlotte Hall, MD 20622
301.375.6118 301.884.5724
Dunkirk Branch La Plata Branch
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10321 Southern Maryland Boulevard 101 Drury Drive
P. O. Box 373 P.O. Box 1810
Dunkirk, MD 20754 La Plata, MD 20646
301.855.6363 301.932.1653
Leonardtown Branch Lexington Park Branch
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25395 Point Lookout Road 22730 Three Notch Road
P.O. Box 241 P.O. Box 561
Leonardtown, MD 20650 California, MD 20619
301.475.5046 301.862.1900